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The Macro Economics Of Corruption
Dr.Akmal Hussain
Newspaper: Daily Times
Dated: Thursday, January 9, 2003

The use of public office for private gain not only lies at the heart of bad governance but can also play a major role in accentuating poverty. As the new elected government begins its career within yet another 'democratic' dispensation, it may be useful to examine the linkage between financial probity, economic growth and poverty. In this week's article we will present a brief analysis of how wide spread corruption by political leaders and government's officials during the 1990s induced adverse changes in the structure of the economy that resulted in slower GDP growth and greater poverty.

According to an estimate by Hafiz Pasha and S.J. Burki, the cost of such corruption to the banking sector alone was 10 to 15 percent of the GDP in 1996-97. They have estimated that the overall cost to the country of corruption at the highest level of government, during the second tenure of the Bhutto government, was 20% to 25% of the GDP in 1996-97, or approximately US $ 15 billion. Their estimate includes the losses incurred due to corruption in public sector corporations such as the Pakistan International Airlines, Sui Northern Gas, Pakistan State Oil, Pakistan Steel, Heavy Mechanical Complex, the Water and Power Development Authority, and the Karachi Electric Supply Corporation. The losses of these public sector corporations had to be borne by the government and constituted a significant element in the growing budget deficits.

Prime Minister Nawaz Sharif also used his public office to enlarge his already considerable private fortune. The device of forcing state controlled banks to lend to family members or family owned companies was persistently used. For example the Ittefaq group owned by Nawaz Sharif's family, borrowed huge funds from a number of co-operative banks and then defaulted on the loans. Similarly some of the industrial units privatized by the Sharif government were handed over to "friends" on very favourable terms. Apart from this a number of additional cases were brought to light by the press subsequently.

Occurring at a time when GDP growth had already begun to fall below its historical trend rate, widespread governmental corruption may have been a significant factor in intensifying the slow down in investment, increasing the economic burden on the poor and perpetuating the inadequacy of basic services during this period.

It can be argued that widespread corruption in Pakistan during the 1990s adversely affected investment and growth in at least three ways: (1) The uncertainty and lack of transparency in government policy and the loss of time and money associated with governmental corruption would create an unfavourable environment for private sector investment. (2) Widespread corruption implied that following an investment decision, the investor would have had to pay bribes at various stages of project approval and implementation thereby raising project cost. A significant proportion of private sector savings directed at new projects would flow to corrupt government officials rather than into productive investment. The consequent decline in the overall productivity of capital in the economy would lead to lower GDP growth for given levels of investment. Evidence shows that such a decline in the productivity of capital did indeed occur in the 1990s. Nomaan Majid has estimated a time series of the total factor productivity in the manufacturing sector and also decomposed it into changes overtime in capital productivity. His estimates show that in Pakistan's manufacturing sector, the productivity of capital has been declining since 1992-93. (3) Since banks and investment finance institutions were being forced to lend on political grounds and there were substantial defaults as a result, it is clear that a significant proportion of banking capital was being transferred as rents to corrupt leaders. This would adversely affect private investment in two ways: (a) There would be lesser credit available for investment. (b) Due to the increased "transactions cost" of banks following defaults, the interest rate for private investors would increase.

The large scale corruption by political leaders and government officials during the 1990s not only slowed down investment and growth but also increased inequality and the economic burden on the lower income groups. This happened in three ways: (1) Increased corruption and mismanagement in government meant that for given levels of development expenditure, there were fewer and poorer quality of public goods and services. This was clearly manifested in the deterioration of the irrigation system with lesser water available at the farm gate, as well as a reduced availability and quality of health, education and transport services provided by the government. (2) The total development expenditure (as a percentage of GDP) itself fell sharply during the 1990s, partly due to budgetary constraints induced by low revenues. The problem of the narrow tax base was accentuated by the massive leakage in the tax collection system due to corruption. According to Burki's estimate this leakage amounted to 3 percent of the GDP, about twice the level ten years earlier. The consequent low revenues, combined with slower GDP growth and high levels of government's current expenditure, led to unsustainably high levels of budget deficits. (3) Since the government was unable or unwilling to plug the leakage in the tax collection system, or reduce non development expenditure, it had to resort to increased indirect taxation to deal with the fiscal crisis. Evidence on the incidence of taxation during the late 1980s and early 1990s shows that the tax burden as a percentage of income was highest at 6.8 percent for the lowest income group (less than Rs.700 per month) and lowest at minus 4.3% for the highest income group (over Rs.4,500 per month). Thus the burden of governmental mismanagement and corruption was passed on to the poorest sections of society.

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