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Consequently, combating corruption has become a major factor in the debate over optimal reform strategies. Numerous theorists have suggested shock therapy as the optimal method to minimize corruption, but empirical evidence shows mixed results throughout transition economies. Overall, state capture and administrative corruption have had extremely negative economic, social, and political consequences that far outweigh any benefits, and have occurred largely as the result of initial conditions and political inefficiency rather than the speed of reform. Before explaining the negative consequences of corruption in transition economies, it is first important to understand the most common types of corruption. The World Bank divides corruption into two main categories, state capture and administrative corruption. State capture encompasses actions by individuals or firms to manipulate the formulation of government laws and regulations to their benefit. This type of corruption usually transpires where there is little social voice and official political influence, benefiting those at the center of a concentrated, economic network. Administrative corruption includes actions that distort the ‘prescribed implementation’ of such laws and regulations, often bribes to public officials that result in selective exemptions to individuals or firms. The Business Environment and Enterprise Performance Survey has compiled corruption figures from transition economies based on these two types of corruption. Despite a high margin of error due to obvious concerns with reliability (given the nature of the subject), results have clearly indicated high levels of corruption throughout the transition economies. State capture has been particularly difficult to measure and often understated in BEEPS data, because it only measures state capture that includes involvement from private firms. Nevertheless, data from this category has proven to be excessively high, especially in CIS countries, where state capture indexes are as high as 41 (as in Azerbijan), indicating an average percentage of firms involved in six different forms of state capture such as the sale of criminal court decisions and the sale of parliamentary votes. Administrative Corruption rates are also astoundingly high, with payments constituting 3.7 percent of annual revenues in CIS countries, 2.2 percent of revenues in Central Eastern Europe, and an alarming 17 percent of profits in the entire region. Results from BEEPS and the EBRD have also shown a direct negative correlation between levels of corruption and various economic and social indicators such as investment and growth, tax payments, poverty, inequality, and the credibility of the state. Together, this empirical evidence indicates the massive, negative impact that results from both types of corruption and identifies corruption as one of the leading causes of transition failure. Administrative corruption and state capture have significantly hindered investments and growth throughout transition economies by creating high levels of uncertainty. Countries with high levels of both categories of corruption have averaged 20 percent less gross domestic investment than those with medium amounts of each category. Firms reporting moderate amounts of administrative corruption report 17 percent average annual sales growth rates over the last three years, while those with high levels of administrative corruption report just 10 percent growth rates in the same period. An opposite trend occurred in state capture figures, with firms engaging in state capture producing 30 percent growth rates, while other firms report a mere 8 percent. However, this is slightly misleading, because overall, states that produce low levels of capture averaged 21 percent growth rates, while those with high levels produced only 11 percent growth rates. These results indicate that despite benefits to particular firms that are received from corrupt actions, there are aggregate macroeconomic repercussions that immensely exceed these smaller scale benefits. The ten year results are staggering, with countries that report high levels of both types of corruption reporting approximately 50 percent declines in output, while countries with medium amounts of corruption barely saw any declines. High levels of corruption have also had extremely negative tax implications and have precipitated unprecedented levels of ‘unofficial economy’. In countries featuring high levels of corruption, the unofficial economy represents nearly 50 percent of the entire GDP. The consequences are that large amounts of income go unreported and tax levels are noticeably low, diminishing government spending for public services, and giving firms greater incentives to continue their corrupt practices. In one astounding example, the government of Ukraine “recently offered an amnesty for an estimated US$20 billion in ‘gray capital’ kept offshore” (world bank 22). Corruption has also had immense social consequences. While colossal declines in GDP have produced drastic increases in poverty rates, recent trends toward economic recovery have not produced significant improvements in poverty rates. This is largely the result of the large amounts of administrative corruption that have not provided “[adequate] social safety nets”, and “have left the most vulnerable groups unprotected. …Surely, poverty can contribute to corruption, …yet corruption also exacerbates poverty” (world bank 20). By diminishing growth rates, corruption can indirectly contribute to vicious cycles of poverty. The World Bank also cites three ways that corruption directly affects the poor. First, inadequate distribution of unemployment benefits, disability benefits, and public service spending affects those at the lowest levels the most, those that require a ‘social safety net’. Second, while larger rates of corruption at the household level affect all classes, they especially affect the poor. In Latvia, 31 percent of households in the poorest bracket reported knowing how to deal with corrupt public service officials, while that figure was 42 percent for the richest bracket. Finally, small businesses and microentrepreneurs are significantly more susceptible to paying bribes than are larger firms, with smaller businesses reportedly paying twice the amount that larger firms pay in bribe money. Corruption is also highly correlated with inequality, and has proven to be a significant contributor to higher gini coefficients in transition economies. Transition countries plagued by high amounts of corruption have gini coefficients that have approached 0.5. These figures are comparable to some of the most unequal Latin American countries, where inequality has been one of the most significant downfalls of development. Yet another negative consequence of corruption is a lack of credibility given to political leadership. When a country does not have faith in its leaders, it certainly does not bode well for the future of its transition and reform process. BEEPS data indicates that in countries with high levels of capture and administrative corruption, a mere 38 percent of firms are content with their political leadership, while this figure is 56 percent in the other transition economies. There is also a significantly greater presence of organized crime in transition countries facing high levels of corruption. 50 percent of firms in countries with high levels of corruption report organized crime as an obstacle to their business, while this figure is around 20 percent in countries reporting medium amounts of corruption. Overall, state capture and administrative corruption clearly hinder progress in transition economies. Results have shown that they have far reaching economic, social, and political repercussions that make up a vicious cycle, often stalling or reversing transition progress. Consequently, economists have prioritized the fight against corruption as an essential part of optimal reform programs. For various reasons, many economists have drawn the conclusion that shock therapy is the best method of combating corruption. In Winners Take All, Joel S. Hellman emphasizes the way in which the winners of the early stages of reform have exploited their advantages in the early stages of reform. “They have incentives to block further advances in reform”, they’ve “undermined the formation of a viable legal system to support the market economy”, and “they have developed a stake in the very distortions that impede the realization of the efficiency gains of a fully functioning market” (Hellman 233). Countries where this form of corruption has occurred have had less overall success than those that have been able to minimize such corruption and to incorporate the voices of the losers in the process of reform. In “countries that adopt more comprehensive reforms, …the transitional costs of reform in the short term are lower than under partial reform, and the losers begin to see gains from reform at an earlier point in the process and at a higher level” (Hellman 221). Overall, Hellman advocates comprehensive reform that successfully incorporates the rights of the losers. Daniel Kaufmann and Paul Segelbaum articulate a similar message in their article on Privatization and Corruption in the Transition. One significant contribution they make is to point out that corruption is not directly correlated with privatization, and that corruption is in fact more prevalent in non-privatized sectors. As a result, “mass privatization techniques, resulting in full transfer of the interests sold, without special deals for insiders and without attaching lingering investment or employment obligations, should be the goal” (Kaufmann 30). Like Hellman, Kaufmann and Segelbaum support mass privatization with an efficient political structure that promotes equality and combats corrupt business practices. These two articles overemphasize the need for mass privatization in the reform process. While they accurately articulate the need for more efficient political systems, they fail to emphasize the importance of initial conditions and to explain the mixed results from the first ten years of reform. The World Bank reports that “there is little systematic research on the conditions that make particular methods of privatization more or less vulnerable to corruption” (32). Black, Kraakman, and Tarassova examine how Russia’s mass privatization program facilitated corruption, and even identify problems that have occurred in Czechoslovakia, a country that has been relatively successful in implementing mass privatization. Black concludes that “mass privatization is likely to lead to massive self-dealing by managers and controlling shareholders unless a country has a good infrastructure” (1731). Without such infrastructure, Russia could not successfully implement rapid privatization, and even in Czecholslovakia, where initial results were promising, increasing ‘tunneling’ in the late 90s has led to a recession. Moreover, partial reform has not always featured the excessive corruption that was predicted by many economists. Hungary and Poland have had relatively low levels of both state capture and administrative corruption, despite their gradualist reform programs. Yet this is not to say that all gradualist reform programs feature less corruption, but rather that the results from each country vary according to their individual situation and particular inefficiencies, and often also depend on initial conditions. Bibliography: Word Count: 1796
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