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Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd

Semester

KIMATHI UNIVERSITY COLLEGE OF TECHNOLOGY


COURSE NAME:

BSC. INFORMATION TECHNOLOGY

MACRO ECONOMICS

TITLE OF STUDY

CORRUPTION AND GOVERNANCE AND THEIR EFFECTS ON ECONOMIC GROWTH

Assignment I

CODE

BIT 2214

STUDENTS

STEVE OUMA OYUGI C025-0346/08

LISHBA NAISINKOI C025-0486/08

ROBERT OWINO C025-0344/08

ANNE NJUGUNA C025-0335/08

BENJAMIN WANJUI C025-0356/08

EFICK WAWIRA KIOI C025-0311/08

PETER IRUNGU C025-0315/08

HEZBORN MUGANDA C025-0323/08

JOSEPH MARWA C025-0314/0

Introduction

Group 3 The Effects of Corruption and Governance on Economic Growth


Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

According to World Bank, Corruption is defined as the abuse of public


power for private benefit. The act often consists of paying bribes to public
officials by private beneficiaries as compensation for the abuse. However,
not all acts of corruption result in the payment of bribes. A powerful
minister can locate a new investment project in his home - town,
unsuitable for that particular activity or he could influence the sanctioning
of big business loans to his cronies and friends and still not take any direct
bribe. However, irrespective of the types or forms of corruption, it needs
no argument that as the act involves subjective misuse of power, it is both
bad and illegal. In addition, the act distorts the purpose for which the
discretionary power was given to the person who abuses it. These
distortions inflict considerable costs on the economy.
According to Transparency International, it refers to abuse of entrusted
power 4 private benefits.

Development on the other hand refers to a sustained elevation of an


entire society and social system towards a better or more human life.
Basically, development is the act of growing or progressing.

Internationally, the study of the causes and consequences of corruption


has a long history in economics, going back 30 years. The classic way
corruption became an economic issue is through “rent seeking activities”.
For most Kenyans, rent is what we pay the landlord each month or what a
rental agency at an airport charges for letting us use a car for a week. For
us as Macroeconomists, however, rent is short for "economic rent".
Economic rent is that extra amount paid (over what would be paid for the
best alternative use) to somebody or for something useful whose supply is
limited either by nature or through human ingenuity. For example, Mike
Tyson, the boxing champion, has a natural and rare talent for flooring his
opponents during the first round and he was paid some a lot of extra
money for exercising this talent.

If he were not a talented boxer, Mr. Tyson's alternative employment would


likely be somewhat more modest, earning less than what his current status
dictates. The difference that he gets is an economic rent accruing to Mr.
Tyson because nature has seen to it that boxers of his skill are in very
short supply.

Similarly, for several years during the 1980s the U.S. government
restricted the import of Japanese automobiles to a certain quota, creating
an artificial shortage of foreign cars. The result? General Motors and other
U.S. car manufacturers not only sold more cars, but also raised their
prices, thereby enjoying an economic rent (the difference between the
price of domestic cars and the cheaper but unavailable Japanese
alternative). This in Kenya occurred with the importation of vehicles such
as the land rover from Europe (English and German territories especially)
until very recently, with the introduction of funny models such as
“Success” and “Body”, which we refer commonly as China models.

In the recent past there have been a number of studies that have reported

Group 3 The Effects of Corruption and Governance on Economic Growth


Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

quantitative results on the effect of corruption on economic variables.


These studies have used cross-section analysis of available corruption
indices and relevant economic indicators. The pioneering effort in this area
was the study by Mauro (1995) who found that corruption lowers
investment and thereby economic growth. Later, the study by Tanzi and
Davoodi (1997) further extended and elaborated this line of causality by
showing that corruption increases public investment while reducing its
productivity. Productivity of public investment was measured through
physical indicators such as the quality of roads, e.g. paved roads in good
condition as a percentage of total paved roads.

Sources of corruption
1. Firstly, trade restrictions are the prime example of a government-
induced source of rents. If importing a certain good is subject to
quantitative restriction (for example, only so many foreign
automobiles can be imported each year), the necessary import
licenses become very valuable and importers will consider bribing
the officials who control their issue. More generally, protecting a
home industry (such as infant industry) from foreign competition
through tariffs creates a semi-monopoly for the local industry. Local
manufacturers will lobby for the establishment and maintenance of
these tariffs and some may be willing to corrupt influential politicians
to keep the monopoly going. Studies have shown that a very open
economy is significantly associated with lower corruption. In other
words, countries tend to be less corrupt when their trade is relatively
free of government restrictions that corrupt officials can abuse.
2. Government subsidies can constitute a source of rents. Studies show
corruption can thrive under industrial policies that allow poorly
targeted subsidies to be appropriated by firms for which they are not
intended. The more such subsidies are available to industries, the
higher the corruption index, an example in Kenya is in the supply of
subsidized fertilizers that was being re-branded by suppliers to be
sold later at a higher price.
3. Price controls, whose purpose is to lower the price of some good
below its market value (usually for social or political reasons), are
also a source of rents and of ensuing rent-seeking behavior. Price
controls create incentives for individuals or groups to bribe officials
to maintain the flow of such goods or to acquire an unfair share at
the below-market price.
4. Multiple exchange rate practices and foreign exchange allocation
schemes lead to rents. Some countries have several exchange
rates--one for importers, one for tourists, one for investors, for
example. Differentials among these rates can lead to attempts to
obtain the most advantageous rate, although this rate might not
apply to the intended use of the exchange. Multiple exchange rate
systems are often associated with anti-competitive banking systems
in which a key bank with government ties can make huge profits by
arbitrating between markets. Some countries have little foreign
currency and distribute what they have through various schemes,
with varying degrees of transparency. If, for example, state-owned

Group 3 The Effects of Corruption and Governance on Economic Growth


Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

commercial banks ration scarce foreign exchange by allocating it


according to priorities established by government officials,
interested parties may be willing to bribe these officials to obtain
more than their fair share.
5. Low wages in the civil service relative to wages in the private sector
are a source of low-level corruption. When civil service pay is too
low, civil servants may be obliged to use their positions to collect
bribes as a way of making ends meet, particularly when the
expected cost of being caught is low.
6. Natural resource endowments (oil, gold, exotic lumber) constitute a
textbook example of a source of rents, since they can typically be
sold at a price that far exceeds their cost of extraction and their sale
is usually subject to stringent government regulation, to which
corrupt officials can turn a blind eye. Resource-rich economies may
be more likely to be subject to extreme rent seeking behavior than
are resource-poor countries.
7. Sociological factors may contribute to rent-seeking behavior. An
index of ethno-linguistic fractionalization (societal divisions along
ethnic and linguistic lines) has been found to be correlated with
corruption. Also, public officials are more likely to do favors for their
relatives in societies where family ties are strong.

Tools of corruption

1. Bribes – This is one of the main tools of corruption. The Oxford


English Dictionary defines a bribe as “ a reward given to pervert the
judgment or corrupt the conduct.” A bribe can also be described as
“giving of money or something valuable to someone in exchange for
a favor especially for something morally wrong or against rule of law
”. It consists of an offer of money by an outside party to secure
desired action from the governmental officials. Bribes can influence
the choice of private parties to supply public goods and services and
the exact terms of those supply contracts. According to Robert
Thobabeen (1991, p.62) buying contracts can be called also
Kickbacks "when government officials may use their bargaining
power with contractors and their discretion in awarding contracts to
obtain a fee or service charge for arraigning the contract.
• Causes of bribery may include: escape facing the law, getting
a job, escape payment of tax or allocation of government
contracts.
• Effects of bribery may include: many crimes may go
unpunished in the case of bribery to escape the law resulting
in closure of businesses and discouragement of foreign
investors. This reduces investment hence reducing national
income and slow development of the economy. In other cases,
qualified professionals are denied the opportunity to exercise
their ability as the jobs they would have gotten have been
wrongly allocated to other people resulting in poor
management and wastage of resources hence causing

Group 3 The Effects of Corruption and Governance on Economic Growth


Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

reduction of national income reducing growth and


development of the country as a whole. Where bribes have
been given to produce low quality products or allocate
contracts to companies, for instance for construction of roads,
it may lead to high fuel consumption which may lead to
increase in prices of commodities and the underperformance
of the road constructors results into wastage of money and
resources that would have been put to good use in developing
other sectors of the economy. Goods brought into the country
illegally may lead to inflation in the country.
• Prevention includes awareness of the harmful trends caused
by bribery due through civic education, adding bribery and its
repercussions as part of the syllabus in the educational system
and observing strict law by persecuting offenders who engage
in acts of bribery.
2. Extortion, which is the converse of bribery is the abuse or threat of
power in such a ways to secure response in payment of money or
other valuable things. Extortion according to the Oxford English
Dictionary "is the act or practice of extorting (defined as either to
wrest or wring from a person, extract by torture or to obtain from a
reluctant person by violence, torture, intimidation, or abuse of legal
or official authority, or – in a weaker sense by importing,
overwhelming arguments or any powerful influence) or wresting
especially money, from a person by force on by undue exercise of
authority or power." It can also be defined as a gross overcharge for
services. Fraud is a deliberate misrepresentation that causes
another person to suffer damages, usually of monetary value. A
perfect example of extortion in our country is when the Saudi’s from
Dubai wanted to do business with Kenya and some government
officials on the Kenyan border tried to extort money from before
they could enter the country. This resulted in Dubai putting
sanctions on Kenya and declaring that no Kenyans can be going to
their country to work without having a first degree as a qualification.
A scenario of fraud is when members, especially managers, of a
company collude to steal from the company. For example former
Philippines president Ferdinant Morcos was accused of stealing
millions of dollars, much of it in American foreign aid. In another
example is the Iran-Contra affair in which profits from the sale of US
government property (antitank and antiaircraft missiles) were
diverted to private arms dealers and to counterrevolutionaries in
Latin America.
• Effects of extortion include: discourage development, for
instance the above case with Dubai, other countries may
get the wrong impression of our country and refuse to do
business with us and Dubai itself cut ties with us leading to
a decrease in the country’s revenue, extortion and fraud in
a company may lead to the said company’s failure resulting
in loss of money hence leading to unemployment. Money
gained from extortion is not taxed hence is not put to good

Group 3 The Effects of Corruption and Governance on Economic Growth


Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

use like being used to improve the infrastructure.


• Prevention of extortion and fraud can be the same as above
under bribery.
3. Another type of corruption is the misuse of public property and
funds. Control of property provides opportunities for
mismanagement and corruption. An extreme form is the large-scale
“Spontaneous” privatization of state assets by enterprise managers
and other officials in some transition economies. According to Leslie
Holmes (1999, p.5) the process of privatization, which is ultimately
implemented by the state provides new opportunities to state
officials. They can demand or request bribes and kickbacks from
private agents interested in purchasing a formerly state-owned
business. At the other end of the scale is petty theft of items such as
office equipment and stationary, vehicles and fuel. The perpetrators
of petty theft are usually middle and lower-level officials,
compensating, in some cases, for inadequate salaries.
4. Grand Corruption/Theft of government financial resources is
another form of corruption, officials may pocket tax revenues or fees
(often with the collusion of the payer, in effect combining theft with
bribery) steal cash from treasures, extend advances to themselves
that are never repaid, or draw pay for fictitious “ghost” workers, a
pattern well documented in the reports of audit authorities.
5. Robert Thobabeen (1991, p.63) brings another form of corruption
called Influence Peddling when individuals with access to people
in high places are sometimes tempted to trade on the influence of
high ranking government officials. "There is money to be made
through sale of access, the arrangement of contracts and timely
intervention to secure favorable disposition of regulatory decisions
and government contract. The use of these kinds of connections for
personal gain is usually described as influence peddling."
6. Patronage is another form of corruption. The assignment of
government positions to political supporters has long been a practice
in politics. While civil service regulations at the national and state
level may effectively curtail the number of patronage jobs, political
appointments remain at the top levels of government and provide a
legitimate way for elected politicians to influence bureaucracy
through the appointment of legal executive officials. The process
becomes corrupt when appointees are expected to pay for their jobs.
The custom of rewarding wealthy campaign contributors with
appointments as ambassadors has been traditional in presidential
politics. Leslie Holmes (1993, p.205) brings three major forms of
patronage. These are the following:

• Nepotism In this context "is the granting of public office on the bases
of family ties." This is a good example of a point where different
cultures have very different attitudes towards some forms of
corruption.
• Racism is the provision of unfair advantage to members of the same
race. This is especially seen in international territories, where

Group 3 The Effects of Corruption and Governance on Economic Growth


Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

contracts are usually awarded to the white race, in the thought that
they are superior in terms of technology and expertise.
• Tribalism is the provision of unfair advantage to members of the
same tribe. This is a very open case in Kenya, where government
offices are sometimes awarded to members of the same tribe.
• Shared experience "there the patron and client have usually worked
together in the past and are on good terms and the patron promotes
or has promoted the client on the basis of these past experience and
warm relationship."
• Shared Interest In this case, "the patron does not have common
experience with someone he she wishes to promote, but rather a
common interest" (for example, they both come from the same
republic and/or are of same ethnic group; they both favor a large
increase in defense expenditure in contrast to what others want,
they are of the same gender.) Another case would be seen where
large contracts may be awarded to foreign investors to facilitate the
ease of future economic bindings such as grants and aid, like Kenya
and China on the road projects.

Causes of corruption
Leslie Holmes (1993 p.157) breaks down the causes of corruption divides
into three categories, cultural, psychological, and system-related.

1. Cultural factor: “In many countries certain types of corruption are


more or less acceptable often depending on the scale in the
traditional political culture.” Some countries have more of a
reputation for corruption particularly because of traditional attitudes
towards family, kinship, etc. For example Leiken Robert (1997)
writes of Africa that "In postcolonial Africa, neo-patrimonial regimes
become the rule, and the state emerged as an extension of the
ruler's household, patronage, ethnic and kinship ties, and bribes
became major modes of governance. Corruption funded patronage
to Kinsman and crimes have exacerbated regional, tribal, religious,
and ethnic divisions. The International Forum for Democratic Studies
estimates that in oil-rich Nigeria some $12.2 billion in government
revenue was divested to "Extra-Budgetary accounts" between 1988
and 1994, and there are no record of how these funds were used.
Nigerians themselves wait in mile-long lines for gas, and Nigeria now
import nearly 70 per cent of its petroleum. Unfinished pipelines,
financed by loans from multilateral development banks that have
been pocketed by government officials, tell a large part of the story.
Oil earnings do less to feed Nigerians than to enrich their corrupt
rulers who instantly transfer their pickings to foreign banks."
2. The other factor of causing corruption is psychological factor.
There are number of psychological factors that help to explain some
types of corruption. Taking into account the internal factors of
individuals some individuals are "naturally evil" and will commit
criminal acts, including corrupt ones in any type of system. The
external factors, individual's relationship to the group is also

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Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

important. According to Holmes (1993, p. 165) “the power of both


peer-pressure and peer-comparison can be great, for instance in the
words of one artist “when the best of people take bribes, isn't it the
fool who doesn't?” In other words if individuals see others around
them benefiting from corruption, they may well choose to indulge
too.” The psychological factor may have some role of causing
corruption in Kenya. People who work in a position that can take
bribes and don't use their chance will be considered by their
coworkers as stupid men. So under the pressure of this factor many
public officials during some period of time become corrupted. But in
many cases because people choose their new job depending on the
scale of opportunity for taking bribes and they know they should
take bribe because this is the way of life.
3. “The other psychological factor that is fear, which can also
encourage people to act corruptly. For example in a hierarchical
situation a subordinate may fear the consequences of not acting in a
similar way to his/her corrupt superior. Another type of fear, which
was more widespread during soviet times in the soviet regions, is
the fear of underfulfilment of the plan that may encourage public
officials to act corruptly. This fear may lead individuals to engage in
corrupt practices, either in order actually to fulfil the plan or else to
appear to have done so (the false reporting syndrome).”
4. Human weakness also may cause corruption. Some people find
it difficult to reject offers from a person of a "generous" nature.
Some officials will accept gifts because they know they have been
particularly helpful to someone and either feels they "deserve" a
reward (that is they feel that a reward is not inappropriate), or else
genuinely do not want to offend or embarrass a grateful supplicant.
5. According to Holmes (1993) “nepotism also as a form of
corruption can be explained in psychological term. "The blood
is thicker than water" syndrome wanting to help one's family.
Nepotism can be explained in terms of individuals seeking to
maximize their own power and the lust for power is a psychological
variable.”
6. System related factors: One of the factors that distinguishes post-
communist states from transitional societies elsewhere is that they
have been undergoing multiple and simultaneous transitions since
the collapse of communist power in 1989-1991. In addition they had
to introduce fundamental economic, legal, ideological and social
change. Many also had to redefine their boundaries and identities,
and realign themselves in international military and trading blocks.
The sheer scope of attempted change is one significant reason why
most post-communist states have suffered a severe legislative lag in
the past decade. This lag has meant that laws have often been
either in essence non-existence or else vague and contradictory.
This situation is ripe for both corruption and organized crime. For a
country like Armenia factors such as Karabakh war of 1992-94,
sharpened the decline in economic activity and income of the
population, which creates favorable conditions for corruption, or in
Kenya, the attempted coup of 1982 banned multipartism, resulting

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Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
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in government going unchecked until 1992.

This brings us to three dimensions of institutional structure that are


considered most critical in bearing on the opportunities for corruption.
1. The monopoly power of officials.
2. The degree of discretion that officials are permitted to exercise.
3. The degree to which there are systems of accountability and
transparency in an institution."
• When officials have monopoly power over provision of a
government good it is crucial for explaining the incidence of
corruption without theft. Monopoly power could exist for the
legal reason that certain officials are the only ones charged
with performing a certain task. Whether an official will be in a
favorable position to extract bribes from clients depends not
only on whether they have a monopoly over their particular
activity, but also upon the rules and regulations regarding the
distribution of government goods.
• The greater the amount of discretion, which is given to an
agent, the more opportunities there will be for agents to give
"favorable" interpretations of government rules and
regulations to businesses in exchange for illegal payments. For
example in terms of the level of discretion, when a custom
agent is allowed to apply one of several tariff rates to a
product, or when a tax inspector is given substantial room to
decide whether companies are given deductions or not, there
will be an incentive to demand a bribe in exchange for offering
favorable treatment.
• Political structure is crucial element in the evolution of
corruption. Political structures where representative processes
to enforce governmental accountability are weak or absent
would be expected to provide the greatest opportunities for
corruption. The judicial system also has an important role in
giving opportunities for corrupt acts. But it is very important
the degree of separation of power between judiciary and
government because it may have very significant influence on
judiciary system in playing its key role. The separation of three
governmental branches in Kenya is in very low level and they
are not independent of each other. The executive power has
obvious dominance over the judiciary branch. The president of
Kenya is the central person for the judiciary system, and this is
because the President of Kenya not only can appoint and
dismiss the Attorney General but also can appoint and dismiss
the Chief Justice and the Judges of all courts. Ministry of Justice
as a part of the executive branch has the right to control and
supervise all courts. So in reality the judicial power is under
the dominance of the executive branch. Political leaders who
maintain very tight control over the judiciary and law-
enforcement sector will typically have the capacity to
undertake corrupt acts with privilege. According to

Group 3 The Effects of Corruption and Governance on Economic Growth


Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
Semester

Transparency International survey results the Judicial system is


the most corrupted sector. To the question “In your opinion,
which sectors boast most cases of corruption?” 64 percent of
the answers was the judicial sector. And also nearly 85 percent
of the respondents agree that there is large size corruption in
judicial system. So the weak and controlled judicial power
creates many opportunities for political leaders as well as for
public officials to act corruptly.

Effects of Corruption
As stated above, recent empirical evidence suggests that corruption
lowers economic growth. This may happen through a wide range of
channels. Herein is a summary of these effects:
1. Entrepreneurs will be aware that their future proceeds and
investments may be claimed by corrupt officials. Payment of bribes
is often required before necessary permits are issued. Therefore
investors may perceive this as a tax – which thus shall reduce their
incentive to invest in such a country.
2. Of particular relevance to African countries and developing nations
as a whole is the possibility that corruption might reduce the
effectiveness of aid flows, ultimately resulting in aid flows financing
unproductive public expenditures. In the recent past, one in which
our country Kenya has faced is the focus on issues of good
governance before the inflow of aid and in some cases where
governance is judged to be poor, some donors have scaled back
their assistance or even stopped providing assistance completely.
3. Corruption may also bring about loss of tax revenue when it takes
the form of tax evasion or the improper use of discretionary tax
exemptions. This falls under corruption when there is counterpart
payment to the tax official responsible.
4. By affecting tax collection or the level of public expenditure then it
can be proven that corruption may have adverse budgetary
consequences. Alternatively, where corruption takes the form of
improper use of directed lending at below market interest rates by
public sector financial institutions corruption may result in an
undesirable lax monetary stance.
5. The allocation of public procurement contracts through a corrupt
system may lead to inferior public infrastructure and services. An
example will be the case of corrupt bureaucrats allowing the use of
cheap, substandard materials in the construction of buildings or
bridges and roads.
6. Corruption may also affect the composition of government
expenditures. Corrupt officials may come to prefer those types of
expenditures that allow them to collect bribes and actually manage
to keep them secret for very long. This is very common in large
expenditures on special items such as weaponry (tanks saga in
Kenya and Somalia, German police helicopters that lay in Kenyan
docks for long without being even taken on test flights) or the
building of roads (Rift valley case where roads are used to dry
maize) and bridges or even dams (dams that remain unused in

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Assignment I MacroEconomics Bsc Information Technology 2nd Year, 2nd
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Kenya since they were constructed on perennial rivers). The details


of such transactions are kept secret by many governments making it
virtually impossible to determine the monetary details of
transactions, compared to the ‘payment of teachers salaries, buying
of textbooks e.t.c.’
7. Where rent seeking proves more lucrative than productive work,
talent will be misallocated. Financial incentives may lure the more
talented and better educated to engage in rent seeking rather than
in productive work, with adverse consequences for the country's
growth rate.

REFERENCES

Mauro P., 1995. “Corruption and growth”. The Quarterly Journal of


Economics, vol. CX, Issue 3.
Rose-Ackerman S., 1996. “The political economy of corruption – causes
and consequences”, Public Policy for the Private Sector, Note No. 74, World
Bank.
Tanzi V. and Davoodi Hamid, 1997. Corruption, Public Investment and
Growth, IMF Working Paper, WP/97/139.
Tanzi V., 1998. “Corruption around the world – causes, consequences,
scope, and cures”, IMF Stuff Papers . Vol. 45, No. 4.
Treisman D., 2000. “The causes of corruption: a cross-national study”,
Journal of Public Economics, vol. 76, No. 3, pp. 399-457.

Group 3 The Effects of Corruption and Governance on Economic Growth