Fighting Corruption Critical for Macroeconomic Stability – IMF

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Christine Lagarde

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A newly released publication by the International Monetary Fund paints vivid picture of the adverse effect of corruption on economic stability, growth and development in countries

THE International Monetary Fund, IMF, is of the view that countries can improve economic stability, boost growth and development by vigorously reducing corruption. The IMF in a new publication entitled: “Corruption: Costs and Mitigating Strategies,” released on its website recently, stated that corruption impedes the conduct of budgetary and monetary policy and weakens financial oversight, ultimately hurting inclusive growth.

The analysis presented in the paper drew on extensive literature on the topic as well as on IMF experience gained in many countries. The paper showed that the topic is “macro-critical” that is, critical to the achievement of macroeconomic stability, which is at the core of the IMF’s mandate.

While hard to measure properly, the economic costs of corruption could be substantial. A recent estimate put the annual cost of bribery at around $1.5 to $2 trillion (roughly two per cent of global GDP). The economic and social costs of corruption could potentially be even larger. The paper observed 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 incentive 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 programmes 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.

While the paper recognised that there is no common recipe for all countries, it also emphasised that a comprehensive approach was crucial. Short-term measures with more immediate impact must be complemented with preventive measures and strict enforcement. In addition, the paper offered policymakers practical guidance, drawing on the IMF’s perspective of helping its members design and implement economic reforms, including anti-corruption strategies. The paper identified 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. To enhance the rule of law, a credible threat of prosecution must exist. Enforcement must also target the private sector. In certain cases, new specialised institutions must be set up where existing ones are corrupt. An effective anti-money laundering framework must be in place to minimise 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. 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,” it said.

According to Christine Lagarde, managing director, IMF: “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. 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,”

—  Jun 6, 2016 @ 01:00 GMT

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