Corruption

STATE CORRUPTION REDUCES MANAGEMENT QUALITY IN THE PRIVATE SECTOR: EVIDENCE FROM EASTERN EUROPE

State corruption severely harms the management quality of private firms, according to research on former communist countries by Daphne Athanasouli and Antoine Goujard, presented at the Royal Economic Society’s 2013 annual conference.

Their study analyses a recent survey of the management and organisation of manufacturing firms in Central and Eastern Europe, as well as measures of corruption based on the average bribes that firms pay to public officials ‘to get things done’. The research finds that corruption significantly decreases the quality of management practices in firms – and their development prospects.

It is a common finding that in more corrupt regions, firms have a lower overall management quality, measured by factors such as monitoring of performance, setting of production targets and employee incentives. These firms also have a much more centralised decision-making process and invest less in the education and training of their workers. Firms located in more corrupt regions also have less innovation and investment in research and development, as well as lower export prospects.

The study seeks to uncover why this is the case by comparing similar firms that differ in the amount they have to deal with public authorities. It finds that for a typical firm, an increase in corruption of 0.4 percentage points, measured by the share of annual sales firms give to bribes, and equivalent to a shift from the corruption level observed in Germany to the average corruption level observed in Belarus, decreases management quality substantially.

This significant decline in management practices is equivalent to a shift from the average quality of management observed in Lithuania to the management quality observed in Kazakhstan.

The World Bank estimates that $1 trillion, around 3.3% of global GDP, is spent on bribes every year. This research is among the first to highlight the underlying mechanisms that drive this relationship between high corruption and a poorly performing private sector.

Transition countries provide an ideal experiment to study the linkages between firm behaviour and corruption. The fall of communism left in place weak legal and political institutions. As a result, corruption and ineffective institutions are commonplace.

The authors conclude:

‘Our findings show that management practices in the private sector are an important channel that can explain the negative effect of corruption on a country’s growth.

‘Corruption can explain the persistent weak economic performance in Central and Eastern Europe, as it damages firm performance and management practices in these countries.’

More…

Corruption considerably deteriorates the management quality of firms in the private sector. This study uses a recent survey on the management and organisation of manufacturing firms in Central and Eastern Europe, and measures of corruption, at the level of administrative regions, based on the average bribes that firms pay to public officials to ‘get things done’. The research finds that corruption significantly decreases the quality of management practices in firms, and their development prospects.

Corruption has a clear effect on the development and performance of firms as it affects their internal structure and management practices. In more corrupt regions, firms have a lower overall management quality, measured by indicators on operation, monitoring of performance, setting of production targets and employee incentives.

These firms are characterised by a substantially more centralised decision process and a lower level of investment in human capital, as indicated by the lower level education among administrative employees. Firms located in more corrupt regions also have a lower level of innovation and investment in R&D, as well as lower export prospects.

The study finds that for a typical firm, an increase in corruption of 0.4 percentage points, measured by the share of annual sales firms give to bribes, and equivalent to a shift from the corruption level observed in Germany to the average corruption level observed in Belarus, decreases management quality by a 0.7 standard-deviation. This significant decline in management practices is equivalent to a shift from the average quality of management observed in Lithuania to the management quality observed in Kazakhstan.

The empirical challenge is that bribing practices in the public sector may evolve in response to firm behaviours. The study circumvents this challenge with its identification strategy of the effect of corruption on management practices. The identification is based on the fact that firms in different manufacturing industries have different exposure to public institutions and the business environment. Indeed, some manufacturing firms rely heavily on business contracts to buy specific production inputs.

For example, computer and electronic equipment manufacturing industries rely heavily on inputs that are not openly traded on an exchange market. Therefore, they heavily depend on business contracts, and their enforcement by regional institutions. By contrast, manufacturing firms that rely on inputs traded on markets are less exposed to regional institutions.

After controlling for differences in regional and manufacturing industry-country characteristics, the researchers find that firms in more contract dependent industries located in more corrupt regions tend to have a lower quality of management, and management practices that hamper their performance and future development. But these contract dependent firms do not appear more affected than other firms by other business barriers such as transport infrastructure, level of taxes and tax administration, or access to finance.

Firms dependent on contracts and located in more corrupt administrative regions systemically report corruption as a more severe barrier in doing business, and in particular corruption in the judicial system, as it could lead to unfair decisions on business disputes and enforcement of contracts.

The World Bank estimates that $1 trillion, around 3.3% of world GDP, is spent on bribes every year. Most of the existing empirical evidence on the relationship of corruption and economic performance is based on studies across countries. There is a lack of understanding of the underlying mechanisms that drive this relationship.

Transition countries provide an ideal experiment to study the linkages between firm behaviour and corruption. Communism bequeathed weak legal and political institutions. As a result, transition countries are still characterised by various forms of corruption and ineffective institutions.

These findings show that management practices in the private sector are an important channel that can explain the negative effect of corruption on a country’s growth. Corruption can explain the persistent weak economic performance in Central and Eastern Europe, as it deteriorates firm performance and management practices in these countries.

ENDS


Contact:

Daphne Athanasouli: Daphne.athanasouli@gmail.com

Antoine Goujard: Antoine.goujard@gmail.com

RES media consultant Romesh Vaitilingam:
+44 (0) 7768 661095
romesh@vaitilingam.com
@econromesh

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