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The Transparency Report 2016 revealed that more than two-thirds of countries struggle with the issues of corruption and this highlights how prevalent it has become since there is no country which is corruption free. The outcome of corruption on the citizens are well known, and they include rising income inequality, poor public service delivery, slow economic development, and limited economic freedom among others. In the business world, corruption impairs private investment, and the misallocation of resources has a detrimental effect on business activities. In this paper, the aim is on the effect of corruption on business activities.
There are various definitions of corruption but the OECD definition as “the abuse of public or private office for personal gain” is generally accepted. Corruption is of two types: grand corruption which refers to the abuse of power by high-ranking political and business leaders for their gain, and the most common form is awarding tenders for a kick-back. Petty corruption is the other type which is more frequent and shared and refers to the abuse of power by middle and low-level ranking officials (Dancikova 3). Vargas-Hernandez identifies various forms of corruption which include bribery, collusion, and embezzlement of public funds, fraud, extortion, favoritism, and nepotism. Bribery is prevalent in the business world, and it refers to the giving of some form of benefit to unduly influence some action or decision on behalf of the beneficiary (Vargas-Hernandez 272)
The world statistics on bribes are shocking because it is estimated by the World Bank that over $1 trillion are given out in bribes every year, almost 5% of the global GDP. Businesses that offer bribes are engaging in corrupt activities, and the overall effect is an unfavorable business environment characterized by an unfair advantage and anti-competitive practices, and the small businesses are mostly the victims. Also, people are not willing to invest in areas where they have to pay a bribe to engage in an activity, and the result is a reduction in private investment. Also, a report by the Independent Broad-based Anti-corruption Commission points out corruption increases the costs of doing business by an average of 10 percent because of the reduced efficiency and inhibition of human labor accumulation.
Corruption in business is a result of seven components: the corrupter, a rare commodity, a seller, an additional incentive, violation of a moral standard, damage to interests, and hiding of the act. Therefore, the corrupter gives a bride to obtain a rare good (tender, license) and the seller (corrupted) receives the bribe. The corruptor offers an additional incentive (kickback), and the corrupted will violate the moral standards, damage third party interests, and finally, conceal the corrupt act (Vannucci 6-8). Forgues-Puccio identifies the corruption risks within the different spheres of business and points out that within the organization, insider trading and corporate is the most common form carried out by the management, the board, and employees (7). The suppliers and customers engage mostly in bribery while competitors and market environment participate in collusion and form cartels.
The most known corruption scandals are the Volkswagen Emission scandal and the FIFA corruption scandal in 2015. The effects of corruption on business activities range from lowering the growth and productivity of firms, inhibiting the development of a healthy marketplace by acting as a deterrence to entry and promoting unfair and anti-competitive practices, lowering the efficiency in business activities, impeding the growth and productivity of firms. In this paper, I will argue that corruption adversely affects business activities by lowering the efficiency in business activities, inhibiting the development of healthy competitive markets, and reducing business growth and productivity. The organization of the paper is as follows: the first part will discuss the three top reasons that cause corruption in business, the second part expands on my argument on the impact of corruption, and the final part suggests solutions to ending this endemic in business activities.
Causes of Corruption in Business Activities
Rent seeking is the first leading cause of corruption in the business world. An underlying assumption of business is that the primary goal of economic agents is the maximization of their welfare, that is, wealth. Therefore, selfish interests feature prominently in economic decisions and therefore, resource allocation decisions are made by where the highest return on investment is. Rent refers to the income of a factor above its competitive returns and individuals are willing to pay bribes to earn some rent, and therefore, corruption is a form of rent appropriation (Begovic5). In economies, the government takes up the role of generating the rent, and it engages in prohibitive practices where economic agents have to seek empowerment before doing anything (Begovic5). An example is in import licenses where only businesses with import licenses have the right to import a certain quantity of goods. The economic rent earned by importers, that is, the difference between the price that consumers will pay for the commodity and the importer’s costs are appropriated to the various agents. Businesses engage in rent-seeking behavior in areas activities which include procurement, infrastructure, and defense (Forgues-Puccio 8), and there is a willingness to pay a bribe with the aim of getting a share of the appropriated economic rent (Begovic 5). According to Pellegrini and Gerlach, state intervention restricts free market operations, and the imposition of trade barriers are opportunities for businesses to earn higher rents (255). Therefore, individuals seek to access trade licenses, and this directly stimulates bribery of political officials and even the regulators themselves.
Lack of transparency in laws and regulation is the second cause of corruption. Begovic points out that the legislation and procedures do not specify time limits for prosecution and sentencing resulting in most corruption cases dragging on for decades. The rules are full of confusion, and they are not publicly available to most individuals. Regular citizens have a hard time in understanding such laws and the opaqueness on the procedures of dealing with corruption inhibits any significant progress in combating the vice. Corruption in business is thriving because there are ineffective and weak controls and inadequate policing presenting tremendous opportunities for individuals to continue with their corrupt acts. The presence of weak law codes and lack of sufficient and strict legislation and regulation motivates the level of corruption in a country
The lack of strict institutional controls is another cause of corruption. Also, most countries have anti-corruption agencies, but they are weak in the enforcement of rules and regulations against the corrupt practice. The institutions are under the political influence, and the effect is that the probability of detecting the perpetrators is low. Most business leaders have a political representative in these institutions who ensure that their names do not feature at all in any investigations. Effective controls should start from within, and they include a clear code of conduct, adherence to professional ethics, and good audit practices. However, in most countries, such checks are not present, and the implication is that very little or no corruption will be detected. Lack of political independence, lack of integrity by the staff, and inability to enforce the law make these anti-corruption agencies ineffective in the fight against corruption. Therefore, in such an environment, businesses are willing to engage in corrupt activities because they are aware that they control the anti-corruption commissions and the chances of discovery and prosecution are low.
Impact of corruption on business activities
Inhibiting the growth of healthy competitive markets
Corruption hinders the growth of healthy markets by acting as a barrier to entry and promoting unfair advantage as well as anti-competitive practices. Furgoes-Puccio points out that corruption is the primary cause of the huge informal sector in most developing countries (2). The opaque laws and regulations impose high costs of entry on firms which can be avoided by a business paying a bribe, and the result is encouraging informality. According to Furgoes-Puccio (2), an improvement by one point in a nation’s corruption index results into a 9.7% reduction in the informal sector. The implication is that only the big companies are players in the market because they have the ability to pay huge amounts in bribes.
Firms such as the small and medium-sized enterprises cannot enter into a market because of the strict regulations to entry, and they lack sufficient funds to bribe the officials. For instance, Charoensukmongkol and Sexton point out that there is massive corruption in the export and import trade in Latin America and Caribbean countries where only some few select firms are allowed to import and export. The effect is that a significant number of businesses are unable to compete in the import and export market leading to stagnancy in the export growth. Allworth gives examples of companies whose innovations are facing stern opposition from the authorities in efforts to protect the incumbent companies. For instance, in the Telecom Sector, Netflix streaming service seems to be the end of cable TV companies, but the incumbents, in turn, are treating Netflix subscribers as second class citizens by limiting the internet download speeds.
Corruption facilitates anti-competitive business activities and practices. Firms will form cartels and engage in price fixing agreements with stakeholders such as suppliers all in efforts of restricting competition in a certain market. Competition is a key feature of a healthy market and firms have to develop ways of reducing costs and innovation. Corruption, in essence, seeks to reward the inefficient firms resulting in an uneven playing ground where dynamic and innovative companies are locked out of the market. Bribery allows certain individuals to have control over the rules of the games, and this is particularly prevalent in procurement. For instance, a report by PWC on Corruption in Nigeria points out the only a few firms can access public goods such as electricity, and this locks out the small and medium companies from competing effectively.
Impedes firm growth and productivity
Forgues-Puccio (3) points out that the informality induced by corruption acts an impediment to growth and productivity. Firms that are unable to pay the bribes have to take their operations underground because they do not have access to public services and even credit services. The inability to access essential services such as water, electricity, and to some extent government credit will limit the growth prospects of firms and negatively affect its productivity. Canon (263) shares the same sentiments by pointing out that increase in corruption results in lower growth levels.
Corruption also hurts the firm level productivity and firms that do not pay bribes in corruption rampant countries have a higher productivity (De-Rosa, Gooroochurn, and Gorg 9). E De-Rosa et al. (9) point out that the red tape and bureaucratic procedures as a result of corruption increases the time that managers and employees will increase trying to negotiate a way out and this hampers firm growth as well as productivity. Corruption negatively affects human resource productivity measures because the employees are devoting greater effort to obtaining licenses and get access to favorable markets. More crucially, corruption will cause the misallocation of resources from the most productive uses to the individuals who can give large amounts of bribes. Firms will also have an incentive to engage in unproductive behavior by seeking to pay bribes rather than to grow market share rather than focusing on innovations and value creating activities.
Corruption also lowers the rate of product innovation in the industry. For an innovator to get entry into a market, permission must be granted from the government as well as the incumbent firms. If there are a large number of innovators, the one who will pay a bribe to the government official will be granted entry into the market. The efficiency of such innovations has not been considered, and it might even have negative effects such as pollution. The corrupt firms also are less likely to engage in innovation because they are assured of protection from innovations by smaller companies. The Report “The costs of corruption in Vietnam, ” point out that such firms are less likely to engage in product improvement by 6.2% and are also less likely to participate in process improvement by 8.7% when compared to bribery free firms (6).
Uber is a perfect example of a company that tries to threaten politically connected incumbents. Uber has posed a significant threat to the politically controlled and heavily regulated Taxi industry, and it has been painted as a bad corporate citizen. In efforts to protect the incumbent taxi companies from the disruptive effects of Uber, extensive licensing requirements and fees have been enacted to protect the incumbents. The regulations are intent on locking out innovators, and Allworth points out the ridiculous Indiana Automotive legislation that requires a dealership to have a minimum of 1,300 square feet.
Corruption lowers efficiency in business activities
Conan (262) points out that results in a drop in efficiency because of four reasons: inadequate specialization, barriers to competition, the inability to protect lenders, and incurring indirect costs. Corruption is a violation of the rule of law, and this reduces contract enforcement between parties. Inadequate contract enforcement results in a bad exchange amongst economic agents because the incentives are no longer present. Poor exchanges result in firms choosing to internally produce their inputs rather than purchasing on the markets. The effects are increasing the level of business uncertainty and abstain from the exchanges leading to a lack of the division of labor. Inadequate division of labor reduces specialization, and consequently, the efficiency of business in its various activities such as manufacturing and provision of services reduces.
Businesses in nations with a low level of corruption can change partners with ease because of the low transaction costs. On the other hand, companies in countries with high levels of corruption have to form partnerships in efforts to protect themselves from the high transaction costs. Such partnerships impose entry barriers as they seek to create a monopoly, that is, cartels which are associated with high transaction costs. In corrupt rampant countries, particular businesses have protection against the loans they have borrowed, and they are not under any pressure to return such funds. Conan (262) points out that these protected borrowers provoke the major creditors to increase the cost of credit cutting down access to finances. The increase in credit results to business uncertainty and firms have to contend with higher costs of inputs, factors that ultimately reduce the efficiency.
Firms also have to incur indirect costs whose overall effect is to reduce the efficiency. The company that pays the bribe incurs corruptive costs because they constantly have to channel to resources to cover their illegal acts. Also, there are opportunity costs incurred in the rent-seeking tendencies and the time and resources expended could have been utilized for greater productive activities. Begovic (6) further points out that businesses incur property protection costs because the prevalence of corruption significantly reduces property rights. Therefore, a business which invests in new innovative processes or makes an investment have to find ways to protect their investments, with hiring security protection the most common. Property rights are crucial in safeguarding the investments of businesses, and they are inadequate in developing countries, particularly in Africa. Investors will not be willing to expand their businesses in areas where there is uncertainty over the safety of their infrastructure.
Solutions to Corruption in Business Activities
It is true that the government has a critical role to play in fighting corruption by strengthening the institutions charged with the fight against corruption, instituting economic reforms, and enhancing the rule of law among others. However, businesses also have a fundamental role in the fight against corruption, and this requires greater transparency and accountability in the conduct of its activities. The first way that businesses can avoid corruption is the development of a corporate governance mechanism. Agrawal and Chadha (374) point out that a critical component of corporate governance is an independent board of directors (BOD) and audit committee. An independent BOD ensures that top officials are not under any political influence and can stand up against corrupt employees. The audit committee, on the other hand, will monitor the operations of the company and detect any strange dealings that might be occurring between the employees and external parties.
Ethical behavior and professionalism are at the core of an effective corporate governance mechanism. Therefore, a business must take a stand in ensuring that all employees right from the top management adhere to the ethical code of conduct and there should be strict penalties for individuals who break them. The code of conduct specifies personal responsibility where each is accountable for their actions and any behavior to give bribes was of their interest, not to benefit the company. An active corporate governance mechanism ensures that immediate action is taken against any individuals suspected of engaging in corrupt dealings such as bribery. Employees are motivated by the fact that they work for a reputable organization whose transactions are transparent. Therefore, it also means that the organizational members are continuously educated on the importance of honesty in business negotiations.
The institutional bodies charged with the prosecution of corruption should be strengthened. There are also regulatory agencies in charge of monitoring business activities, and they should also be equipped to enhance transparency and the rule of law. There have been cases of companies who continuously deal with corrupt suppliers and employees without any action taken. Business individuals have to face a credible threat of prosecution to change their conduct. Strengthening these institutions will require the input of organizations and various stakeholders, and it is of essence that their objectives are clarified. Also, the employees within these agencies must possess the technical expertise of complicated business dealings and more importantly, be people of unquestionable integrity.
Corruption is a rampant problem all over the world, and it causes stagnation in economic growth, poor public service delivery, and the misallocation of productive resources. When it comes to business, bribery is the most common form of corruption and statistics indicate that over $1 trillion is used in bribery every year. The discussion has revealed that the causes of corruption in business are the rent-seeking behavior of firms, the lack of transparency in laws and regulations, and the weak institutional bodies. Corruption has adverse effects on business activities, and the discussion has shown that it results in unhealthy markets by creating barriers to entry, reducing the growth and productivity of firms by inhibiting innovation and reducing efficiency through the incurrence of transaction costs. The paper suggests that an active corporate governance mechanism and the strengthening of the anti-corruption institutions and agencies are crucial to stop and avoid the severe corruption epidemic.
Allworth, J. (2017). How Corruption Is Strangling U.S. Innovation. Harvard Business Review. Retrieved 5 July 2017, from https://hbr.org/2012/12/how-corruption-is-strangling-us-innovation
Begovic, Boris. "Corruption: concepts, types, causes and consequences." Center for Liberal-Democratic Studies, Year III No 26 (2005)
Danon, Marko. "Contemporary economic research of corruption." Contemporary Legal and Economic Issues 3 (2011): 252
De Rosa, Donato, Nishaal Gooroochurn, and Holger Görg. "Corruption and Productivity." (2010)
Pellegrini, Lorenzo, and Reyer Gerlagh. "Causes of corruption: a survey of cross-country analyses and extended results." Economics of Governance 9.3 (2008): 245-263
Vannucci, Alberto. "Three paradigms for the analysis of corruption." Labour & Law Issues 1.2 (2015): 1-31
Vargas-Hernández, José G. "The multiple faces of corruption: Typology, forms and levels." (2009)
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