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April 14, 2016

The human cost of corruption


April 14, 2016

The recent exposures in the Panama Papers scandal have reinforced long-standing public suspicions of misappropriation of public funds, tax evasion and money laundering by some of Pakistan’s leading politicians.

There is also a strong perception amongst citizens of endemic corruption in the bureaucracy. Evidence of this phenomenon is provided by a number of authoritative international organisations as well as public figures. For example Transparency International in its 2013 report estimated that tax evasion amounted to R2000 billion (about $19.4 billion) annually. In its 2013 survey, of all the respondents, 75 percent reported paying bribes for land transaction services, 55 percent to the tax department, 65 percent to the police and 36 percent to the judiciary.

The staggering amount of money stashed in foreign banks by Pakistanis (not necessarily all ill-gotten gains) was brought to public notice when Federal Finance Minister Ishaq Dar revealed to parliament that Pakistanis had deposits of $200 billion in Swiss banks alone. It is not surprising, therefore, that the World Economic Forum’s Global Competitiveness Report 2015-16, on the basis of its survey data, has identified corruption to be the most important constraint to doing business in Pakistan. In view of the magnitude and endemic nature of financial corruption within Pakistan’s bureaucracy and political leadership, it may be helpful to analyse its human cost for the people of Pakistan.

It can be argued that widespread corruption has adversely affected investment and growth while at the same time increasing economic inequality. The negative impact of corruption on investment and growth occurs in at least two ways. First, widespread corruption implies that following an investment decision, the investor would have to pay bribes at various stages of project approval and implementation, thereby raising project cost. Consequently, a significant proportion of private-sector savings aimed at new projects would actually flow to corrupt government officials or politicians rather than into productive investment. This would reduce the productivity of capital and lead to lower GDP growth for given rates of investment.

Second, since banks and investment finance institutions were reported to have been pressured during at least the 1990s, to lend on political grounds, there were substantial loan defaults. Thus a significant proportion of banking capital was being transferred as rents (unearned income) to corrupt politicians and or their clients. This would adversely affect private-sector investment: first, less credit would be available for productive investment. Second, due to the increased “transaction cost” of banks following defaults, the interest rate for loans to private investors would tend to increase.

Large-scale corruption by political leaders and government officials has not only slowed down investment and growth but also increased inequality and the economic burden on the poor. This happened in three ways. For one, 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 manifested in the deterioration of the irrigation system with lesser water available at the farm gate, ceteris paribus. At the same time the availability and quality of health, education and transport services was constrained.

Secondly, the total development expenditure as a percentage of GDP itself has been falling sharply, partly due to budgetary constraints imposed by the massive tax evasion and leakages in the tax collection system due to corruption. In 2013, the revenue loss to the government due to tax corruption amounts to 7.3 percent of GDP.

Finally, the corruption-related loss of revenues, combined with slower GDP growth, led to unsustainably high levels of budget deficits. Since the government was unable or unwilling to plug the tax leakages, it had to resort to indirect taxation to deal with the incipient fiscal crisis. Evidence of the incidence of taxation of an earlier study showed that the tax burden as a percentage of income was highest at 6.8 percent for the lowest income group and lowest at minus 4.3 percent for the highest income group. This means that indirect taxation tended to increase the disposable income of the rich and reduce the disposable income of the poor. Thus the burden of indirect taxation partly induced by corruption was passed on to the poorest sections of society.

Consider now the opportunity cost of corruption for the people of Pakistan. There are currently 11.1 million school age children out of school. At present cost per student of schooling all out of school children can be given school education for an additional $1.5 billion. A 10-fold increase in this expenditure to $15 billion is required to substantially improve the quality of school education. Setting up a world class university (there are none at the moment), would require an endowment fund of about $40 billion (Harvard has an endowment fund of about $36 billion).

Health expenditure needs to increase three fold. Over ten years this comes to a total of $80 billion, to provide decent healthcare to the people over a decade. Universal provision of school education, healthcare and a world class university would cost $135 billion. This could be financed if the $200 billion currently claimed to be in Pakistanis’ accounts in Swiss banks alone were available. The remaining $65 billion could help to further strengthen Pakistan’s defence capabilities.

Corruption by successive governments has not only been a factor in undermining the economy, intensifying the deprivation of the poor, constraining defence expenditure but also endangers the very legitimacy of the political system that brings such governments repeatedly into power.

The writer is a professor of economics at the Forman Christian College University, Lahore.

Email: [email protected]



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