Governance and Anti-Corruption Reforms in Developing

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iiiGovernance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward

PREFACE

The G-24 Discussion Paper Series is a collection of research papers preparedunder the UNCTAD Project of Technical Support to the Intergovernmental Group ofTwenty-Four on International Monetary Affairs and Development (G-24). The G-24was established in 1971 with a view to increasing the analytical capacity and thenegotiating strength of the developing countries in discussions and negotiations in theinternational financial institutions. The G-24 is the only formal developing-countrygrouping within the IMF and the World Bank. Its meetings are open to all developingcountries.

The G-24 Project, which is administered by UNCTAD’s Division on Globalizationand Development Strategies, aims at enhancing the understanding of policy makers indeveloping countries of the complex issues in the international monetary and financialsystem, and at raising awareness outside developing countries of the need to introducea development dimension into the discussion of international financial and institutionalreform.

The research papers are discussed among experts and policy makers at the meetingsof the G-24 Technical Group, and provide inputs to the meetings of the G-24 Ministersand Deputies in their preparations for negotiations and discussions in the framework ofthe IMF’s International Monetary and Financial Committee (formerly Interim Committee)and the Joint IMF/IBRD Development Committee, as well as in other forums.

The Project of Technical Support to the G-24 receives generous financial supportfrom the International Development Research Centre of Canada and contributions fromthe countries participating in the meetings of the G-24.

GOVERNANCE AND ANTI-CORRUPTIONREFORMS IN DEVELOPING COUNTRIES:

POLICIES, EVIDENCE AND WAYS FORWARD

Mushtaq H. Khan

Professor of EconomicsSchool of Oriental and African Studies

University of London

G-24 Discussion Paper No. 42

November 2006

viiGovernance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward

Abstract

International institutions and in particular the World Bank and the IMF are rightly giving agreat deal of attention to issues of governance in developing countries, and particularlycorruption. While they are right to believe that governance matters, governance in the mostsuccessful developing countries has often been starkly at variance with the good governancemodel. Even the most successful developing countries have suffered from significantcorruption and other governance failures during the early stages of their development. Thisshould not be interpreted to mean that corruption and the goals of good governance are notimportant. Pressure to reduce corruption and move towards good governance is bothnecessary and desirable but these ends cannot be achieved unless attention is also given toother governance capacities required for accelerating and sustaining growth. The verydesirable goals of good governance may be neither necessary nor sufficient for acceleratingand sustaining development. We identify a number of different structural drivers of corruptionthat operate because of the poor fiscal capacities and structurally weak property rights ofdeveloping countries. These imply that aggregate corruption is likely to be high in alldeveloping countries, but successful countries have institutions and governance capabilitiesthat enable them to “manage” the structural drivers in ways that allow economic developmentand in turn create the conditions for a sustained improvement in good governance. In contrast,other developing countries lack these institutions and capabilities and suffer from pooreconomic prospects and political instability to varying extents. The challenge for developingcountries is to learn the right lessons from the international experience and identify reformagendas appropriate and feasible for their own circumstances. Even the most successfulanti-corruption strategies are unlikely to result in dramatic across-the-board improvementsin most developing countries. But if they are properly designed to attack the most damagingeffects of particular types of corruption, they may still be very successful in acceleratingeconomic development and improving the conditions of political viability. The currentgovernance and anti-corruption agendas supported by international agencies do not achievethis. They do not identify the structural drivers of corruption, and they do not identify feasibleresponses to these drivers that are likely to improve development prospects in particularcountries. More worryingly, by setting broad anti-corruption and good governance goalsthey may be doing damage by setting unachievable targets for developing countries anddiverting attention from critical governance reforms.

ixGovernance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward

Table of contents

Page

Preface ............................................................................................................................................ iii

Abstract ........................................................................................................................................... vii

1. The new agenda of good governance and anti-corruption ..................................................... 3

2. The empirical evidence ............................................................................................................... 5

3. Conventional anti-corruption policies: the “greed plus discretion” analysis ..................... 12

4. Structural drivers of corruption in developing countries ..................................................... 14

5. Conclusions ................................................................................................................................ 21

References ........................................................................................................................................... 22

List of tables

1 Interdependent good governance reform agenda ......................................................................... 42 Governance and growth, 1980–1990 ............................................................................................ 73 Governance and growth, 1990–2003 ............................................................................................ 84 Corruption and growth, 1980–1990 .............................................................................................. 95 Corruption and growth, 1990–2003 ............................................................................................ 10

List of figures

1 Analytical foundations of good governance ................................................................................. 42 Governance and growth 1980–1990 ............................................................................................. 73 Governance and growth 1990–2003 ............................................................................................. 84 Corruption and growth 1980–1990 ............................................................................................... 95 Corruption and growth 1990–2003 ............................................................................................. 106 Governance reforms critical for growth versus good governance reforms ................................ 117 Drivers of political corruption in developing countries ............................................................. 168 Drivers of non-market asset transfers in developing economies ................................................ 189 Critical drivers of predation and extortion ................................................................................. 19

International institutions and in particular theWorld Bank and the IMF are rightly giving a greatdeal of attention to issues of governance and institu-tions in developing countries, and they are particu-larly concerned with corruption. There is strongevidence that governance and institutions matter inaccelerating development and in reducing povertyin developing countries. However, the evidencestrongly suggests that there is no common set of in-stitutions that all successful developing countrieshave shared. More worrying is the observation thatgovernance and institutions in the most successfuldeveloping countries have often been starkly at vari-ance with the good governance model that interna-tional agencies are committed to. Even the mostsuccessful developing countries have suffered fromsignificant corruption and other governance failuresduring the early stages of their development. How-ever, they did have significant governance capaci-ties that allowed states to ensure that the conditionsfor rapid growth and sustained political legitimacyof the state were maintained. A sustained pressureto reduce corruption and improve governance is both

necessary and desirable but these ends cannot beachieved unless attention is also given to the gov-ernance capacities required for accelerating and sus-taining growth. The very desirable goals of goodgovernance may be neither necessary nor sufficientfor accelerating and sustaining development. Nev-ertheless, some types of anti-corruption and govern-ance reforms are likely to be part of a sustainabledevelopment strategy in most countries. The chal-lenge for developing countries trying to devise in-stitutional reform and anti-corruption strategies isto learn the right lessons from the internationalexperience and create feasible governance reformagendas appropriate and feasible for their own cir-cumstances. The current governance and anti-cor-ruption agendas do not achieve this and may evenbe doing damage by setting unachievable targets fordeveloping countries and diverting attention fromcritical governance reforms.

Section 1 discusses the analysis behind the newgovernance and anti-corruption agendas that havebeen widely adopted by international agencies. This

GOVERNANCE AND ANTI-CORRUPTIONREFORMS IN DEVELOPING COUNTRIES:

POLICIES, EVIDENCE AND WAYS FORWARD*

Mushtaq H. Khan

* This work was carried out under the UNCTAD Project of Technical Assistance to the Intergovernmental Group of Twenty-Four on International Monetary Affairs and Development with the aid of a grant from the International Development ResearchCentre of Canada.

2 G-24 Discussion Paper Series, No. 42

agenda is based on developments in economics thatidentify the importance of reducing transaction costs.However, this policy agenda is based on a partialreading of theory and evidence. Section 2 discussesthe empirical evidence on which the agenda of goodgovernance and anti-corruption reforms is based. Itshows that despite serious weaknesses in this data,in particular its foundation in subjective indices, thedata is far less supportive of the dominant policyagenda than appears at first sight. By separating con-verging and diverging developing countries, we showthat the differences in governance and corruptionbetween these groups are negligible. We concludethat while there are significant governance differ-ences between these two sets of developing coun-tries, these are not captured in the conventionalgovernance indicators. A range of case studies haveidentified some of the critical governance capacitydifferences between these countries, and policyshould focus on adapting these lessons to the initialconditions of reforming countries.

Section 3 discusses the specific analytical ar-guments behind the anti-corruption policies followedin many developing countries and supported by in-ternational agencies. Mainstream anti-corruptionpolicy is based on the assumption that corruption iscaused primarily by the greed and discretionary pow-ers of public officials, an analysis that we describeas the “greed plus discretion” theory of corruption.The major policy planks of conventional anti-cor-ruption policy (liberalization, privatization, increas-ing salaries for public officials, rule of law reforms,greater transparency and democratization), all fol-low from this. However, here again, econometric andcase study evidence suggests that these policies havenot achieved very much in reducing corruption.

Section 4 identifies four other types of corrup-tion in developing countries that point to a differentset of drivers that are not addressed by conventionalanti-corruption policies. The first is the corruptionand rent seeking that is associated with necessarystate interventions that cannot be addressed throughprivatization or liberalization. Here the reform pri-ority should be to strengthen state capacities to carryout these functions, and at the same time to legalizeand regulate the associated rent seeking.

The second is the important area of politicalcorruption associated with attempts of many devel-oping country states to maintain political stability ina context of severe fiscal scarcity. This driver of

corruption cannot be addressed using any of the con-ventional programmes, and indeed explains whypolitical corruption is ubiquitous in developing coun-tries. The reform priority here should be to identifythe organization of patron-client politics in eachcountry and to limit the most damaging effects. Thelong-term solution is to increase fiscal space to thepoint where political stabilization can be achievedthrough transparent fiscal transfers to all deservingconstituencies.

The third driver of corruption is the structuralweakness of property rights in countries where mostassets are still unproductive and cannot pay for theirprotection. This structural problem is strongly sup-ported by New Institutional Economics but has notfound its way into the policy discussions aroundgovernance and anti-corruption reforms. We arguethat the importance of this driver also explains whyweakly protected property rights and the associatedcorruption appear to be ubiquitous in developingcountries, even in high-growth ones. However, high-growth countries have strategies to ensure that criticalproductive sectors enjoy the stability of expectationsthat allows high-value investment and growth tocontinue and this should inform feasible reform ef-forts in other developing countries.

Finally, predatory corruption and extortion arepotentially the most serious problem for some de-veloping countries. While the state collapse thatallows predation to become dominant has manycauses, its critical characteristic is the collapse ofthe enforcement capacities of the central state. Here,anti-corruption strategies have to recognize the im-portance of strengthening the enforcement capacitiesof states at risk of descending into predation.

Our analysis of the drivers of corruption canhelp to explain why all developing countries sufferfrom relatively high levels of corruption in aggre-gate. But while all corruption is damaging to someextent, some types of corruption are much more dam-aging than others. The evidence strongly supportssuch an interpretation. While all developing coun-tries suffer from corruption at early stages ofdevelopment, high-growth countries suffered lessfrom the most damaging types and they also hadgovernance strategies that allowed them to avoid themost damaging effects of other types of corruption.

Section 5 concludes. The policy implication ofour analysis is that the focus on corruption in gen-

3Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward

eral (and a long list of good governance reforms) indeveloping countries diverts attention away fromfeasible policies that can make a difference to economicperformance. If there are many different types of cor-ruption in developing countries, and if it not possi-ble to attack all of them simultaneously, it is criticalto acquire the governance capabilities to identify andlimit the most damaging types of corruption. A frame-work for distinguishing between types of corruptionis critical for setting national institutional reformpriorities and successful anti-corruption strategies.

All these arguments point to the importance ofhaving institutional reform and anti-corruption strat-egies tailored to the particular circumstances of coun-tries. Without that, anti-corruption strategies andinstitutional reform agendas can have a damagingeffect by setting developing countries unattainabletargets and creating demoralization and reform fatigue.

1. The new agenda of good governanceand anti-corruption

Corruption takes place when public officialsbreak the law in pursuit of their private interest. Themost odious forms of corruption include bribery andextortion, but it can also include other forms such asthe allocation of public resources to favoured cli-ents for political benefit. Clearly, corruption is a costto developing countries in many different ways, in-cluding the subversion of development plans, thediversion of resources that may have been investedproductively, as well as disrupting the transparentand normal operation of markets and thereby creat-ing uncertainty for investors. However, in recentyears, there has been a much more concerted focuson corruption coming from international agenciesbased on an integrated analysis of the role of gov-ernance in improving the prospects of developmentin developing countries.

The new analysis of corruption forms part ofan integrated analysis of good governance. The corearguments come from New Institutional Economicsthat has defined efficient markets as markets withlow transaction costs. Transaction costs are the costsof conducting transactions, and include in particularthe costs of negotiating and enforcing contracts. Ifthese costs are very high, markets are inefficient,and critical transactions like long-term investments

are unlikely to happen. It turns out that the goodgovernance conditions that many people in devel-oping countries desire as goals of development cantheoretically be presented as preconditions or meansfor ensuring development, because they are institu-tional and political conditions for ensuring low trans-action costs in market economies.

The economic analysis supporting the goodgovernance reforms promoted by international agen-cies is summarized in figure 1. Poor performance ineconomic development is explained (arrow 1 in fig-ure 1) by inefficient, high transaction cost markets(North, 1990; North, 1995). The persistence of ineffi-cient markets (arrow 2 in figure 1) is in turn explainedby welfare-reducing interventions of governments, butmost importantly, by insecure property rights that areexpensive to protect and transact with. The persist-ence of unstable property rights and welfare-reducinginterventions in developing countries is then ex-plained (arrow 3 in figure 1) by rent seeking andcorruption through which small numbers of rentseekers buy themselves the ability to capture prop-erty or induce interventions that help them at theexpense of broader society (Krueger, 1974; Mauro,1995; Bardhan, 1997; Mauro, 1997a; Mauro, 1997b;Kaufmann et al., 1999). But why are these relativelyfew beneficiaries of corruption and rent seeking ableto continue their activities even though the vast ma-jority of society suffers? The answer (arrow 4 infigure 1) is that the majority is poorly organized andthere is an absence or weakness of democratic ac-countability that allows the minority to effectivelyexploit the majority (Clague et al., 1997; Olson,2000). Poverty and underdevelopment in turn limitthe organizational capacity of the majority (arrow 5in figure 1), thereby locking the system into sus-tained poverty and underdevelopment.

It is from this theoretical perspective that thegood governance analysis proposes a set of parallelpolicy priorities that have to be simultaneously fol-lowed to break out of the poverty trap described infigure 1. These interrelated set of policies combineeconomic reform with institutional and political re-form and have come to be known as the goodgovernance reform agenda. Some of the critical com-ponents of this package are summarized in table 1.Its novel feature is that it explicitly goes beyond thetraditional focus of economic reform on market com-petitiveness to include a wide range of political andinstitutional reforms. Thus, instead of simply focus-ing on arrow 1 in figure 1, that is on economic


reforms such as liberalization, the good governanceagenda in table 1 argues that it is necessary to si-multaneously address institutional reforms thatimprove the stability of property rights and the ruleof law (arrow 2 in figure 1), anti-corruption reformsand attacks on rent seeking more widely (arrow 3)

and reforms that seek to improve the accountabilityof governments (arrow 4). Clearly, anti-corruptionreforms play a significant role in the new reformagenda, and this is why anti-corruption reforms havean importance well beyond the importance of cor-ruption seen as a problem in isolation.

Contested/Weak Property Rights and Welfare-Reducing

Interventions

High Transaction Cost Markets

Rent-Seeking andCorruption

Unaccountable Government

��

�

�

�

Economic Stagnation

Figure 1

ANALYTICAL FOUNDATIONS OF GOOD GOVERNANCE

Table 1

INTERDEPENDENT GOOD GOVERNANCE REFORM AGENDA

Policies to improve accountability Policies to counter corruption Policies to stabilize property rightsof government and rent seeking across the board

PRSP, PGBS (in some countries), Anti-corruption policies, Policies to improve rule of law,accountability reforms, liberalization, WTO restrictions reduce expropriation risk,decentralization on subsidies, IMF fiscal strengthen judiciaries

requirements


2. The empirical evidence

The empirical evidence shows that while thereis at best a weak relationship between the govern-ance conditions identified in the good governanceagenda and improved economic growth; there areother more important governance conditions neces-sary for accelerating and sustaining economic growththat are not identified at all in the good governanceapproach. The identification of the most importantconditions for accelerating and sustaining economicdevelopment is clearly of paramount importance fordeveloping countries. While the good governanceconditions are for the most part desirable on theirown terms, the empirical question is whether the goodgovernance agenda identifies the necessary conditionsand critical priorities for reform. Our examination ofthe empirical evidence suggests that it does not. Laterwe will argue that the good governance conditionsand in particular a drastic reduction of corruptionmay not even be achievable in most developing coun-tries, regardless of their potential benefit.

An immediate problem for any comparativeempirical work is that governance quality and par-ticularly corruption cannot be directly measured andso proxy indicators have to be constructed usingsubjective judgements and opinions. These indiceshave well-known problems of bias and subjectivity.In particular, small differences in scores of coun-tries, either over time or compared to other similarcountries are not trustworthy (Khan, 2006a; Søreide,2006). Nevertheless, even if we use these indicators(which are widely used in policy advocacy) a care-ful examination reveals that some of the strongresults in support of the good governance agendaderived using these indicators cannot be justified.This is a particularly important conclusion given thelarge number of econometric studies that appear toshow some relationship between governance indi-cators including corruption, the rule of law, and othergood governance characteristics and economicperformance (Knack and Keefer, 1995; Mauro, 1995;Knack and Keefer, 1997; Mauro, 1997a; Johnson etal., 1998; Hall and Jones, 1999; Kaufmann et al., 1999).

These relationships are strongest for relation-ships between governance quality and per capita in-come, in effect showing that richer countries havebetter governance, lower corruption and so on. Butthe direction of causality is difficult to establish insuch studies because it could be that higher per capita

incomes and levels of development in general al-lowed the emergence of better governance condi-tions. For corruption and other governance indicatorsto be accepted as policy targets, we need to estab-lish a relationship between these governance indi-cators and economic growth rates. To begin with,the relationship with growth rates is much weaker,and often disappears with the inclusion of other vari-ables such as the investment rate (Mo, 2001). Butthis is not the only problem.

While there is no reason to deny that if sustain-able improvements in corruption and other govern-ance variables could be achieved, overall economicperformance, even in terms of growth rates wouldimprove to some extent, the evidence in support ofthis is very weak and calls for much greater cautionin the design of reform priorities. The main problemin empirical studies is that we have to be careful tocompare like with like, and it is very difficult to iden-tify two countries that are different only in terms ofa governance indicator. In particular, countries areat different levels of development, and to make senseof their growth performance, we need to at least splitthe countries into an advanced (high income) coun-try group and the rest, which we can loosely describeas the developing country group including transi-tion economies.

Most of the relationships between good gov-ernance characteristics and economic performanceappear to emerge when we pool all countries to-gether. But more interesting insights emerge whenwe split countries into advanced and others, and thensplit the latter group into a group of converging anda group of diverging countries. Converging coun-tries are developing countries that are converging toadvanced country living standards as a result ofachieving growth rates higher than the advancedcountry average. Diverging countries are those thatare falling further behind as a result of growth ratesthat are lower than the advanced country average.Grouping countries in this way reveals some strik-ing features in the data that casts doubt on some ofthe core aspects of the conventional wisdom. Weconclude that while there are very likely to be im-portant governance differences between convergingand diverging developing countries, these differencesare not captured in the indices of good governanceon which conventional policy focuses.

Our figures 2 to 5 and the accompanying ta-bles 2 to 5 use governance and corruption indices


from the IRIS centre at the University of Maryland,compiled by Knack and his colleagues (IRIS-3,2000). While all indices of governance suffer fromsignificant problems of subjectivity, these indices arewidely used and suffice to demonstrate the main fea-tures of the problem. (Similar results are obtained ifwe use the World Bank’s indices compiled byKaufmann et al. (2005) except that the latter indicesare only available from 1996). The IRIS governanceindex is available from 1984 and is an amalgam offive separate indices for “corruption in government”,“rule of law”, “bureaucratic quality”, “repudiationof government contracts”, and “expropriation risk”.It ranges from 0 (the poorest score) to 50 (the highestscore). We also use the corruption index separately,which ranges from 0 (the poorest score) to 6 (thehighest score).

Looking at the two decades of the 1980s and1990s, we plot the governance indicator for the be-ginning of a period against the per capita growthrate achieved in that country in the subsequent dec-ade. As the earliest governance indices are onlyavailable from 1984, the exercise for the 1980s isless accurate than for the 1990s. This is because weexpect higher per capita incomes to lead to bettergovernance over time, and if a country has beengrowing rapidly for a while, its higher per capitaincomes will dispose it to better governance charac-teristics even if these did not exist at the beginningof the period. Thus, if our governance data comesfor a year in the middle or towards the end of thegrowth period, we could wrongly conclude in somecases that better governance had caused growtheven though the causality was in the opposite direc-tion.

As we would expect, our data plots show thatadvanced countries score better on all governanceindicators compared to developing countries, but toa large extent this could be because there is a re-verse causality operating from higher levels of percapita incomes to better scores on these specificgovernance indicators. The really interesting obser-vations are for comparisons of converging (highgrowth) and diverging (low growth) developingcountries. The data show that the difference in gov-ernance indicators for these two groups is negligibleboth in terms of general governance as well as foreach specific governance indicator. Of the differentcomponents of the overall governance indicator, wehave also shown the results for the corruption indi-cator.

Figure 2 and table 2 show that for the 1980s,the pooled data for all countries shows a weak posi-tive relationship between good governance qualityand economic growth. However, a closer look showsthat the overall governance indicator was only verymarginally better for converging developing coun-tries compared to diverging developing countries.More important, both were significantly worse thanadvanced countries. The very small difference be-tween converging and diverging developing countriesis particularly noteworthy given that the governanceindicator for the 1980s is only available for 1984,almost halfway through the decade. But in any case,the very large difference in growth rates betweenconverging and diverging developing countries isassociated with a very small difference in govern-ance quality.

The comparison between converging and di-verging developing countries becomes even starkerwhen we look at the data for the 1990s in figure 3and table 3. Once again, there is no significant dif-ference between converging and diverging develop-ing countries, but during this decade, the medianconverging developing country had a marginallypoorer governance index compared to the mediandiverging developing country. We should not readtoo much into this reversal except to say that thisconfirms even more definitively that the two sets ofdeveloping countries did not differ significantly interms of their performance in terms of good govern-ance.

These results just reported for the overall gov-ernance indicator are replicated when we look atindices for each of the component governance char-acteristics out of which the overall governanceindicator is constructed. The corruption index is oneof the key constituent indices of most governanceindicators, and we now turn to data on the corrup-tion index on its own. In the 1980s, convergingdeveloping countries scored slightly better on the1984 corruption index compared to diverging de-veloping countries, but both scored significantlyworse than advanced countries (figure 4 and table 4).This simply replicates the result for the overall gov-ernance indicator.

However, just as with the overall governanceindicator, in the 1990s (figure 5 and table 5) the slightdifference between converging and diverging devel-oping countries disappears completely. The mediancorruption index in converging and diverging de-


Table 2

GOVERNANCE AND GROWTH, 1980–1990

Diverging ConvergingAdvanced developing developingcountries countries countries

Number of countries 21 52 12

Median Property Rights Index, 1984 45.1 22.5 27.8

Observed range of Property Rights Index 25.1–49.6 9.4–39.2 16.4–37.0

Median per capita GDP growth rate, 1980–1990 2.2 -1.0 3.5

Source: IRIS-3 (2000), World Bank (2005).Note: The IRIS Property Rights Index can range from a low of 0 for the worst governance conditions to a high of 50 for the best

conditions.

Figure 2

GOVERNANCE AND GROWTH 1980–1990

Source: IRIS-3 (2000), World Bank (2005).

veloping countries was exactly the same in the 1990s,though both scored significantly worse on corrup-tion compared to advanced countries. The weakpositive relationship between the corruption andother governance indicators and economic growthin the pooled data is therefore misleading. A similar

analysis for other governance indicators is availablein (Khan, 2006c).

This does not mean that there are no signifi-cant governance differences between converging anddiverging developing countries. However, it does

-7

-5

-3

-1

1

3

5

7

9

11

0 10 20 30 40 50

IRIS Property Rights Index 1984 (ranges from 0 to 50)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

198

0–90

Advanced Countries Converging Developing Countries Diverging Developing Countries


Table 3

GOVERNANCE AND GROWTH, 1990–2003



Median Property Rights Index, 1990 47.0 25.0 23.7

Observed range of Property Rights Index 32.3–50.0 10.0–38.3 9.5–40.0

Median per capita GDP growth rate, 1990–2003 2.1 0.4 3.0

Source: IRIS-3 (2000), World Bank (2005).Note: The IRIS Property Rights Index can range from a low of 0 for the worst governance conditions to a high of 50 for the best

conditions.

mean that the important differences in their govern-ance characteristics are not identified by the goodgovernance analytical framework.

This proposition is summarized in figure 6.Converging and diverging developing countries

(groups 1 and 2 in figure 6) do not differ signifi-cantly if at all in terms of their average governancecharacteristics, but they differ very significantly interms of their economic growth performance. Thelack of any significant difference between groups 1and 2 is even more remarkable if we remember that

Figure 3

GOVERNANCE AND GROWTH 1990–2003


-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50

IRIS Property Rights Index 1990 (ranges from 0 to 50)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

199

0–20

03



Table 4

CORRUPTION AND GROWTH, 1980–1990



Median Corruption Index, 1984 5.4 2.6 3.0

Observed range of Corruption Index 3–6 0–6 1–5

Median per capita GDP growth rate, 1980–1990 2.2 -1.0 3.5

Source: IRIS-3 (2000), World Bank (2005).Note: The IRIS Corruption Index can range from a low of 0 for the worst corruption to a high of 6 for the lowest corruption.

countries in group 2 are considerably richer thanthose in group 1 because they have typically beengrowing for some time.

The challenge for diverging developing coun-tries is how to improve their growth performance,

and for converging countries, to sustain and improveon what they have already achieved. The good gov-ernance agenda suggests that diverging countries(group 1) could aspire to become group 3 countriesby implementing good governance reforms andmoving rightwards and upwards in the diagram.

Figure 4

CORRUPTION AND GROWTH 1980–1990


-7

-5

-3

-1

1

3

5

7

9

11

0 1 2 3 4 5 6 7

IRIS Corruption Index 1984 (ranges from 0 to 6)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

198

0–90



Table 5

CORRUPTION AND GROWTH, 1990–2003



Median Corruption Index, 1990 5 3 3

Observed range of Corruption Index 2–6 0–5 0–5

Median per capita GDP growth rate, 1990–2003 2.1 0.4 3.0

Source: IRIS-3 (2000), World Bank (2005).Note: The IRIS Corruption Index can range from a low of 0 for the worst corruption to a high of 6 for the lowest corruption.

However, this assertion is based on the type of theoryand evidence discussed above, and not on any his-torical observation of any developing country thatfirst improved the governance characteristics de-scribed as good governance and then increased itsgrowth rate even to advanced country levels.

Rather, the historical evidence tells us verystrongly that the challenge for diverging countriesis to discover the policy and governance changesthat allowed countries to graduate from group 1 togroup 2 and stay there for several decades. Even forgroup 2 countries, the challenge is often to under-

Figure 5

CORRUPTION AND GROWTH 1990–2003


-8

-6

-4

-2

0

2

4

6

8

10

-1 0 1 2 3 4 5 6 7

IRIS Corruption Index 1990 (ranges from 0 to 6)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

199

0–20

03



stand better what they themselves have achievedoften through serendipity or good luck so that thegood performance can be sustained over time. It isundoubtedly true that once growth has set in, it isdesirable to carry out second phase good govern-ance reforms that allow the country to graduate fromgroup 2 to group 3. This transition is by no meansautomatic and it may even be that some of these re-forms are necessary to sustain growth in countriesthat are becoming mature. However, there is littleevidence that these second stage reforms are fullyimplementable in poor countries, and no evidencethat these reforms are preconditions for growth inpoorly performing countries.

The governance capacities that have sparkedoff and sustained growth in group 2 have been thesubject of extensive research by development econo-mists specializing in this field. This research hasidentified a number of specific governance capaci-

ties that distinguish converging developing countries.These include capacities for protecting the assets andresources of critical productive sectors, directingassets and resources to these sectors, assisting thesesectors to acquire more advanced technologies, regu-lating and disciplining the market so that there arecredible compulsions for productivity growth in pro-ductive sectors, and maintaining adequate socialstability and legitimacy through redistributive strat-egies. Some of this literature is reviewed in Khan(2004).

The problem is that there was no single set ofinstitutions that achieved these ends (and that too tovarying degrees) in different countries. The govern-ment-business partnership that achieved (some or all)of these goals in the Republic of Korea in the sixtieswas very different from the strategy followed by Ma-laysia in the 1970s, and very different again fromthat in China’s export-oriented industries or in In-

Figure 6

GOVERNANCE REFORMS CRITICAL FOR GROWTH VERSUS GOOD GOVERNANCE REFORMS

Source: Khan (2004).

Gro

wth

Rat

es

Governance Characteristics(Degree of Democracy,Extent of Corruption,

Stability of Property Rights)

1. Diverging Developing Countries

2. Converging Developing Countries

3. Advanced CapitalistCountries

Regression Line

Reforms suggestedby Good Governance

and related frameworks(but very little historical evidence of this trajectory )

Reforms that transform Failing Statesinto Developmental States

Reforms that improve

governance in

successfultransformation

economies


dia’s software sector. These differences in the inter-national arrangements that sustained growth can betraced to differences in initial institutional, politicaland economic conditions, since new institutions donot just have to address critical economic require-ments; they also have to be implementable given thepolitical settlement and the already existing institu-tional capacities of the state (Amsden, 1989; Wade,1990; Khan, 2000a; Khan and Jomo, 2000; Rodriket al., 2002; Rodrik, 2003; Khan, 2004; Rodrik andSubramanian, 2004).

In its much earlier study of the role of govern-ance in East Asian development, the World Bank(1993) recognized the critical role of the state in therapid developers in assisting technology acquisitionand upgrading, but concluded that because thesegovernance capacities were missing in other devel-oping countries, it would be very risky for theaverage developing country to follow these strate-gies. In one sense this conclusion was correct becausewithout appropriate governance capacities, the at-tempt by states to accelerate and sustain developmentwould only result in mistakes with the added costsof rent seeking. However, this conclusion was actu-ally very misleading because it implicitly assertedwithout any evidence that there was another routefrom group 1 to group 3 in figure 6 that was basedon states acquiring good governance capacities. Ourargument is that there is no historical evidence forthis.

In effect, the World Bank was asking countrieswith very poor governance capacities to achieve newgovernance capacities (good governance) that nopoor country had historically achieved and claim-ing that these governance capacities would thenensure faster growth, for which again there was noconvincing historical evidence. A more reasonableresponse to the evidence would have been to arguethat the best option for developing countries with-out group 2 governance capacities would be to tryand acquire at least some of the governance capaci-ties of the rapid developers that would have allowedthem to achieve faster rates of social transformationthan they were achieving.

Since the publication of the World Bank’s EastAsian study (World Bank, 1993), a wealth of newcase studies and evidence has become availablewhich suggest that this is a critical policy and re-search agenda. But the objectives of this policy andresearch agenda will not be a simple blueprint for

all countries to follow. Rather, it has to focus on iden-tifying feasible governance reforms tailored for eachcountry that seeks to achieve improvements in per-formance by finding local solutions to some of theproblems addressed in more ambitious ways in thehigh-growth developers. Examples of these studiesinclude Rodrik (2003) and Khan and Jomo (2000),and some of the critical governance capacities inhigh-growth developers are summarized in Khan(2004).

These studies do not suggest that all develop-ing countries can or should emulate the Republic ofKorea, China or India. Rather, they advocate a muchmore nuanced approach that involves looking at thefunctions that the state performed in the better per-formers, the governance capacities that were requiredand the institutions that achieved this in each spe-cific context. To achieve similar functions, even atlower levels of effectiveness, other countries needto ask what types of governance capacities and in-stitutions they could feasibly try to achieve to meetsome of the economic requirements for acceleratingthe structural transformation of their economies intohigher growth and higher income economies.

3. Conventional anti-corruptionpolicies: the “greed plus discretion”analysis

Having identified corruption and governanceas preconditions for rapid development, the main-stream approaches to reform carry out a furthersimplification that has important policy conse-quences. They argue that corruption is largely causedby the greed of public officials who have the discre-tion to offer citizens benefits or cause damage to theiractivities but who are inadequately monitored or faceinadequate punishments for violating laws. If bureau-crats or politicians have the power to offer selectivebenefits or cause selective damage, and if their riskof detection or risk of punishment is low, they arelikely to engage in corruption to enrich themselves.

There is a large academic and policy literaturethat develops aspects of this analysis of the causesof corruption (Rose-Ackerman, 1978; Klitgaard,1988; Andvig and Moene, 1990; Shleifer and Vishny,1993; Mauro, 1995; Bardhan, 1997; Leite andWeidmann, 1999). Although there are differences in


detail in the analysis of corruption provided in theseand similar contributions, the similarities betweenthem on the core drivers allow us to collectivelydescribe it as the greed plus discretion theory ofcorruption.

The standard policy response to corruption isentirely based on attacking the drivers of corruptionidentified in greed plus discretion theories. The well-known collection of measures to attack corruptionderived from this analysis include:

(i) reducing the discretion of public officialsthrough liberalization and privatization,

(ii) improving salaries of public officials, therebyaddressing their low living standards in manycases, but also increasing the opportunity costof corruption since they stand to lose their po-sitions if detected,

(iii) improving the rule of law so that corrupt bu-reaucrats and politicians can be prosecuted andpunished, and

(iv) encouraging greater transparency of govern-ment decision-making through deepeningdemocratization, decentralization and thecreation and encouragement of civil societywatchdogs.

If corruption in developing countries was in-deed entirely or even largely driven by the factorsidentified in the greed plus discretion theory ofcorruption, the adoption of these anti-corruptionmeasures in a wide range of developing countrieswould by now have produced significant reductionsin corruption in the countries adopting them. Unfor-tunately, we know from detailed econometric andcountry case studies that many of the core policytools identified in the greed plus discretion theorieshave limited if any effect on corruption.

(i) For instance, we have a wide range of case stud-ies from the Indian subcontinent and EasternEurope that show that policies of reducing statediscretion through liberalization and privatiza-tion have done little to reduce corruption indeveloping and transition countries. Indeed,liberalization and privatization have beenaccompanied by dramatic increases in corrup-tion in most cases (Harriss-White and White,1996).

(ii) Higher salaries and rewards for public officialsare unlikely to work even in theory unless theyare backed up with a credible probability ofofficials losing their positions if caught engag-ing in corruption (Besley and McLaren, 1993).Since achieving the latter requires very deepchanges in political and legal structures, it isnot surprising that cross-national empirical evi-dence shows that there is little if any relationshipbetween pay increases for public officials andreductions in corruption (Rauch and Evans,2000; Treisman, 2000).

(iii) While there have been many programmes toimprove the rule of law in developing coun-tries, there is little evidence that these have hadany effect, and the empirical evidence raisesserious questions about the degree to whichpromoting the rule of law in developing coun-tries has assisted in the reduction of corruptionor the achievement of any other developmentobjective (Carothers, 2003).

(iv) Strategies of improving transparency and set-ting up new bodies such as ombudsmen andcommissions are the easiest for external agen-cies to support, so not surprisingly this is anarea in which a lot of international policysupport has focused. But in a review for the Op-erations Evaluation Department of the WorldBank, Huther and Shah (2000) agree that manystrategies such as introducing ombudsmen andraising public awareness of corruption are un-likely to have any effect on countries wheregovernance is poorest. Yet they still argue thatreducing the size of the state, increasing citi-zen participation and (somehow) improving therule of law are still the best strategies in coun-tries with the worst governance record.

On the link between democratization and cor-ruption, Treisman (2000) in his major cross-countryregression analysis finds no evidence that corrup-tion is lower in democracies. Democracy did have asmall effect on corruption after many decades butthese long term effects could have other explana-tions because only successful economic developersare usually able to sustain long-lasting democracies.

On decentralization, cross-country regressionanalysis that includes both advanced and develop-ing countries (such as Gurgur and Shah, 2000) re-port that decentralization has a significant effect in


reducing corruption. But this study, for instance, alsopoints out that when the regressions are carried out fordeveloping countries alone there is no relationshipbetween decentralization and corruption-reduction.The latter result is more significant because includ-ing both advanced and developing countries in thesame regressions have problems which we havetouched on earlier.

These and other studies that have looked at theempirical evidence on each of the links crucial forthe greed plus discretion theory of corruption warnus that the policy focus of conventional anti-corrup-tion strategies is unlikely to achieve sustainedreductions in corruption, even if the reduction ofcorruption were indeed a critical precondition fordevelopment. The empirical evidence should havealerted policy-makers that there are likely to be otherstructural drivers of corruption that are not linked tothe greed and discretion of public officials (though thatmay also be one of a number of drivers of corruption).

4. Structural drivers of corruption indeveloping countries

The “greed plus discretion” theory of corrup-tion ignores a number of structural problems thatdeveloping countries face that in turn induce highlevels of corruption of different types. Understand-ing these structural drivers of corruption can allowus to adopt more reasonable positions on anti-corruption policies in developing countries, as wellas allowing us to design anti-corruption policies totarget the most damaging types of corruption. Thesecritical structural drivers of corruption include thefollowing:

(a) Corruption associated with necessary stateinterventions

A very serious problem with the conventionalanti-corruption agenda is that it presumes that anydiscretionary intervention on the part of public in-stitutions is damaging because such powers are notonly unnecessary for accelerating development, theycreate in addition, opportunities for extortion bypublic officials. But this assumption is wrong. Ac-celerating economic development requires themanagement of a number of critical interventions,for instance, to assist domestic producers to catch

up by learning to use new technologies (Khan,2000b). The evidence of such interventions from allthe successful Asian developing countries is over-whelming. These interventions are in addition to theinterventions that states need to make on a flexiblebasis to sustain welfare. Many of these interventionsare useful and states have to acquire the capacity toidentify, sustain and manage these interventions.Whenever states have essential functions that areboth socially beneficial and also benefit particularconstituencies, there will necessarily be some rentseeking that needs to be managed to ensure that so-cially desirable outcomes can continue to be achieved(Khan, 2000a; Khan, 2004).

While liberalization is not a solution here, someof the anti-corruption strategies advocated in theconventional anti-corruption programme may helpif they could be feasibly implemented. For instance,improving the rule of law or increasing the opportu-nity cost for bureaucrats by paying them highersalaries may help in reducing corruption in areaswhere the state has critical functions to perform.However, we have seen the evidence that shows thatthese strategies either do not work or take a longtime to implement. To improve the effectiveness ofstates in critical intervention areas, alternative strat-egies of dealing with damaging rent seeking have tobe followed.

Paradoxically, the answer may lie in the waysin which advanced countries have dealt with rentseeking. States in advanced countries play importantroles in managing their economies, and inevitablythis creates incentives for extensive rent seeking. Butmuch of the rent seeking in advanced countries islegalized because the underlying interventions andrents are themselves legal. This allows the rent seek-ing to be legally regulated (for instance by allowingindustry groups to lobby to promote their interestswithin prescribed limits) whereas the rent seekingin developing countries often takes illegal forms thatare by definition corruption. This is because theemerging modern sectors in developing countries arenew and interventions to assist them are often infor-mal and lack wide political support, though this isnot the case in all developing countries, particularlythe more advanced ones.

A critical distinction here has to be made be-tween the intended outcome of an intervention andthe cost of the rent seeking it induces. If the rentseeking does not seriously affect the outcome of the


intervention, the resources used up in the rent seekingare a social cost, but the net effect of the interven-tion can still be very positive (Khan, 2000a). Boththe capacity of the state to ensure the effective im-plementation of the intervention and the institutionsthat can limit the rent seeking cost are important,but the former are most important, because there isno point in these critical areas to limit the rent seek-ing cost but fail to achieve the most of the intendedoutcomes of intervention. Thus, the priority for de-veloping countries must be to strengthen the capacityof the state to assist growth in critical areas such astechnology acquisition or the provision of criticalinfrastructure for productive sectors. Nevertheless,all developing countries can significantly reducecorruption by identifying these critical state inter-ventions, legalizing these interventions where theyare not already properly regulated, and this will al-low the legalization and regulation of the associatedrent seeking as well. At the same time, policy has tostrengthen state capacities and regulatory mechanismsto manage and regulate both the intervention and theassociated rent seeking.

If we look at the successful high-growth de-velopers, while all of them continued to suffer fromsome corruption even in critical areas, their institu-tional capacity in these sectors ensured that corrup-tion did not compromise critical state functions evenif they resulted in some rent seeking or even corrup-tion. Strengthening these capacities should thereforebe a critical focus of anti-corruption strategies but itgets very little attention in the reform agenda pre-sented to developing countries.

(b) Fiscal constraints and the structural driversof political corruption

The other drivers of corruption in developingcountries are even more difficult to deal with, butstates need to devise strategies over the medium termto avert the most damaging effects of these types ofcorruption. One of the fundamental problems facedby states in developing countries is to maintain po-litical stability in a context of severely limited fiscalresources. Maintaining political stability in any coun-try requires, amongst other things, the availabilityof sufficient fiscal resources for redistribution to con-stituencies that have political power or social legiti-macy but have lost out (even if only in their ownperception) in the allocation of income and resourcesthrough economic processes. Advanced countries taxbetween 35 to 50 per cent of their GDP, and a sig-

nificant part of this is redistributed to different con-stituencies to maintain social cohesion and politicalstability. In contrast, the lower share of the modernsector in the economies of developing countries, to-gether with institutional weaknesses means that theycan typically tax only around 10 to 25 per cent oftheir GDP, and their GDP is of course, much smallerto begin with. In most developing countries, afterthe salaries of public servants have been paid, thereis not much left even for delivering essential serv-ices or constructing critical infrastructure. In manydeveloping countries, core developmental spendingis financed by domestic borrowing and externalflows, leaving very little fiscal space for politicalstabilization through transparent official redistribu-tions through the budget though some budgetary re-distribution does of course take place.

Nevertheless, developing countries do havepowerful constituencies demanding redistributionand political stability has to be maintained. The lim-ited redistribution possible through the budget typi-cally does not achieve this goal. This structuralproblem explains the importance of patron-clientnetworks in every developing country. Off-budgettransfers through patron-client networks to powerfulconstituents are a remarkably common mechanismfor maintaining political stability across developingcountries (Khan, 2005b; Khan, 2006b). This is un-fortunately an inherently corrupt process becausepolitical power is used to benefit particular clients,and by extension, benefit their political patrons whostay in power through these mechanisms. While po-litical scientists and sociologists have pointed outthe myriad different social cleavages around whichpatron-client factions are formed in developing coun-tries, the ubiquity of patron-client factions across alldeveloping countries regardless of their cultural his-tories, economic strategies and even their politicalinstitutions demands a more comprehensive expla-nation.

The common economic problem that develop-ing countries face in maintaining political stabilityin a context of fiscal scarcity provides an importantpart of such an explanation. If resources have to beprovided to specific and critical constituencies thatcannot be provided to all deserving groups becauseof fiscal scarcity, then these transfers have to be ar-ranged less than transparently through patron-clientnetworks. If in addition these resources are not avail-able in the budget, governments have to raise therequisite off-budget resources through processes that


are likely to involve corruption or the toleration ofcorruption on the part of critical constituents. Thus,both the raising of resources for political stabilizationand the allocation of at least some of these resourcesto critical constituents is likely to involve politicalcorruption.

While these processes are not desirable and alldeveloping countries aspire to progress to a stagewhere they can be dispensed with, the fact is thatthe drivers of these types of corruption have noth-ing very much to do with the greed or discretion ofpublic officials even though greed and discretion mayallow some types of corruption to be deployed inthese contexts, and also allow public officials to ben-efit greatly from these systemic drivers. Rather, assummarized in figure 7, the main driver of this typeof corruption is the fiscal constraint and the need forpolitical stabilization, and till the fiscal constraintcan be overcome, the chances of making seriousdents on this type of corruption are likely to remainrather limited.

However, while patron-client politics and theassociated political corruption are common to alldeveloping countries, the outcomes of these proc-esses for economic development are quite different.

Thus, as figure 7 shows, patron-client politics cansometimes achieve political stability and therebyallow growth, but at other times it can also fail. Thedifference between success and failure is not theabsence of political corruption in some developingcountries, but more subtle differences in the organi-zation of patron-client politics and the managementof factional demands (for a more extensive analysissee Khan, 1998; Khan, 2000a; Khan, 2006b).

Our analysis of the drivers of political corrup-tion is consistent with the persistent evidence ofpolitical corruption in all developing countries. It isalso consistent with the persistent failure of reform-ing anti-corruption governments in developingcountries. Even when elected on massive popularmandates and even when they have just replaced verycorrupt governments, reforming governments appearto succumb to corruption with depressing regularitywithin relatively short periods of time. This evidencesuggests that strong structural drivers are at workand that these are powerful enough to eventuallyovercome the intentions of even committed and hon-est individuals at the highest levels of government.These experiences should tell us that transparencyand accountability reforms on their own are not likelyto resolve this problem given the financial constraints

Figure 7

DRIVERS OF POLITICAL CORRUPTION IN DEVELOPING COUNTRIES

Political Collapse and End of Accumulation

Sufficient Political Stability for Growth and Accumulation to Continue

Politically Driven Corruption to Raise

Off-Budget Resources

Political Stabilization using Off-Budget Resources and

Patron-Client Networks

Severely limited Fiscal Resources

Poor Economy (Largely Pre-Capitalist )


of achieving political stability through transparentfiscal transfers. We also have many case studies ofcorrupt politicians beating honest ones in electionseven when their corruption is well-known and thereis no issue of transparency. The conventional analy-sis ignores the fact that corrupt politicians can winbecause they are often the only ones who can de-liver, even if delivery in this case means delivery toselective but critical constituencies.

This argument does not mean that political cor-ruption is acceptable simply because it is verydifficult to fight it. Nevertheless, it does mean thatthe fight against political corruption should be struc-tured in such a way that it is not doomed to fail, andthat achievable results are attained while keeping aneye on the long-term goal. There may be importantgovernance reforms that are needed to ensure thatpolitical stability is maintained and the most dam-aging aspects of political corruption that seriouslythreaten human and social development, or threatento destabilize and delegitimize the state are ad-dressed. The identification of governance reformsthat are appropriate for addressing these problemshas to be a country-specific process, and is not likelyto be helped by broad anti-corruption strategies thatcannot be implemented to any significant extent.

The differences between developing countriesin how they operate their patron-client politics lie insubtle differences in the organization of politicalparties, factions and patron-client groups. Histori-cal evidence of path changes in economic perform-ance (for instance in the Republic of Korea in theearly 1960s or in Malaysia in the early 1970s) cor-relate very well with changes in internal politicalorganization in these countries that allowed politi-cal stability to be achieved even if patron-client poli-tics did not immediately disappear altogether (Khan,2000a). The conventional governance agenda doesnot provide any entry points for developing andtransition countries to identify their governance weak-nesses in this area or to assist them in constructing vi-able governance reform packages that can address someof the more damaging aspects of political corruption.

(c) Weak property rights and the prevalence ofnon-market asset transfers

A related structural problem in many develop-ing countries is that property rights are contestedand weakly protected because of the limited publicresources available for adequately defining and pro-

tecting property rights. In much of the conventionalanalysis of governance and corruption in develop-ing countries, it is implicitly assumed that theprotection of property rights can be dramaticallyimproved through governance reforms and by re-ducing corruption. This analysis ignores the economicfact that constructing a nation-wide system of stableproperty rights is an extremely costly enterprise andadvanced countries only achieved significant stabil-ity in their property rights at a relatively late stageof their development when most assets had achievedhigh levels of productivity (Khan, 2002; Khan, 2004;Khan, 2006b).

One of the significant conclusions of the NewInstitutional Economics introduced by DouglassNorth and others was to point out that the protectionand exchange of property rights was an extremelycostly business. These costs were described as trans-action costs, and New Institutional Economicspointed out that in advanced economies, transactioncosts may account for as much as half of all eco-nomic activity (North and Wallis, 1987; North,1990). An efficient economy has slightly lower trans-action costs than others, but it never has zerotransaction costs or anything approaching that. Inaddition, in an efficient market economy like theUnited States, transaction costs may be low for in-dividual transactors at the point of exchange (this isthe definition of an efficient market) but collectivetransaction costs for the economy as a whole are notlow at all. These collective transaction costs can bepaid for because almost all assets in an advancedcountry are very productive (by definition) and sotheir owners can pay the taxes and incur the privateexpenditures on legal and security systems that en-sure that at the point of exchange, transaction costsare low. In a developing country, most assets are oflow productivity and cannot pay the cost of theirown protection. It is not surprising that every devel-oping country suffers from contested and weakproperty rights.

Figure 8 shows the drivers of this instability ingraphical form. When most of the assets in a coun-try have not yet achieved high productivity uses(which is by definition the case in a developing ortransition economy), it is difficult to imagine howthe protection of property rights across the boardcan be paid for. Developing countries have to livewith a much higher degree of property right insta-bility compared to advanced countries, but this isnot entirely or even largely due to the greed and dis-


cretion of their public officials. When property rightsare not secure to any satisfactory extent, and trans-action costs at the point of exchange are high,inevitably many transactions will be too expensiveto conduct through the market. This is why non-mar-ket transfers are ubiquitous and much more significantin developing compared to advanced countries.

Non-market transfers include not just the highprofile cases of appropriation and theft using politi-cal power, but also cases of legal but non-markettransfers through land reform, state allocation of landfor development, and a much more extensive use ofthe right of eminent domain in allocating public re-sources. These processes are structurally necessaryin developing countries but do open up the possibil-ity of abuse and corruption. But as with patron-clientpolitics and political corruption, they are not likelyto be stopped by simply addressing the greed anddiscretion of public officials as there are deeper struc-tural factors driving these processes. And as withpatron-client politics, the outcomes of these non-mar-ket asset transfers can result in a successful transitionto a modern capitalist economy or to predation andloss of resources to overseas tax havens. The differ-

ence between these two outcomes is not that in onecase there was good governance and in the other therewas not. Rather, the difference is again a much moresubtle set of institutional and political factors thatcreate incentives and compulsions for public andprivate actors benefiting from non-market transfersto ensure investment in productive enterprises.

The case study evidence strongly supports ouranalysis. Whether we look at China at one end of thegrowth spectrum or at many other developing coun-tries in Asia and Africa whose growth rates put themat the other end of the spectrum, they all share a highdegree of contestability of property rights in theireconomies as a whole though with very differenteconomic outcomes. The differences between themare subtle in that in countries like China, investorsin productive sectors enjoy considerable stability intheir expectations of protection of future profits (pro-vided they continue to remain profitable). However,if we look at property rights across the board, themajority of asset owners even in China are likely toface contestable property rights exactly as our analy-sis suggests. In contrast, in poorly performing countriesthe problem is that productive entrepreneurs often

Figure 8

DRIVERS OF NON-MARKET ASSET TRANSFERS IN DEVELOPING ECONOMIES

Resources Captured by Unproductive Groups: Economic Collapse

Resources Captured by Emerging Capitalists: Emerging Capitalism

Non-Market Asset Transfersinvolving political and state actors

Factions and Public Officials exploiting opportunities

Low-Productivity Economy(unable to pay for enforcement)


face great uncertainty about their expectations andas a result investments are low (Khan, 2004).

Once again, this analysis should not give uscause for complacency about the importance of gov-ernance. Rather it should direct our attention to amore critical set of governance reforms that are ableto create stable expectations for critical sectors to en-able accelerated investment and growth. In contrast,trying to implement reforms that attempt to achieveproperty right stability across the board in poor coun-tries that lack the economic resources to make itfeasible is likely only to result in frustration and even-tually the abandonment of the reform programme.

(d) Predation and expropriation

The most damaging type of corruption in mostdeveloping countries is predatory corruption by thestate where public officials use their political or mili-tary power to expropriate from citizens. Thepatron-client politics of developing countries andnon-market asset transfers have characteristics ofpredation even in the best of cases and are always atrisk of descending into a degree of predation andextortion that obstructs investment and development.The dividing line between patterns of patron-clientpolitics that allow political stability to be maintainedand the point at which these processes become sodamaging to development that they are judged to beprimarily predatory is clearly a very grey one. Simi-larly, non-market transfers of assets often have anelement of predation and extortion for those who

fail to get what they would consider to be fair valuefor their assets or are denied access to bid for assetsthat others are getting access to.

The critical difference between cases of patron-client politics and non-market transfers that accom-pany rapid processes of social transformation on theone hand and predatory corruption may appear tobe a subtle one. However, a common feature of thelatter countries is the institutional and political frag-mentation of the state, which has proceeded to anextent that the state is unable to prevent lower levelfunctionaries acting to enrich themselves even whenthis damages the stability, income and survival pros-pects of the state itself (Shleifer and Vishny, 1993;Khan, 1996). When the state is cohesive and its dif-ferent agencies can be coordinated institutionally andpolitically, it is unlikely that “normal” patron-clientpolitics or non-market transfers will descend intooutright predation. This is simply because higheragents of the state will in their self-interest restrainlower level officials or particular agencies whoseappropriation threatens the interests of those higher up.Nor are the central agencies likely to engage in all-out expropriation if their time horizon is longer thanthe very short ones that are characteristic of leadersin collapsing states. The critical role of state cohesive-ness in explaining the difference between straightfor-ward predatory outcomes is summarized in figure 9.

To the extent that state cohesiveness is a criti-cal factor explaining predatory outcomes, themainstream anti-corruption programme may be se-

Figure 9

CRITICAL DRIVERS OF PREDATION AND EXTORTION

Expropriation and Predation inducing collapse of productive

sectors

Weak Protection of Assets and Incomes

Political Factions seeking to Capture Assets and Incomes

Fragmentation of Central State


riously missing the critical problems in some of themost poorly-performing developing countries. Inthese countries, transparency, salary increases oranti-corruption watchdogs and aid penalties are un-likely to have any significant effect at all. Theappropriate policy focus in these vulnerable statesshould be to strengthen the state’s capacity to be-have in a cohesive and effective way. In other words,the agenda in these countries should focus on con-structing a Hobbesian state in a context where thestate is falling apart rather than to focus on AdamSmithian reforms of limiting the freedom of the state(Khan, 2005a). The latter agenda is very stronglybased on the greed plus discretion explanation forthe myriad problems besetting poorly performingdeveloping countries.

Our argument is that the descent into predationin some of the weakest developing countries is notprimarily caused by the greed and discretion of theirpublic officials but rather by the inability of theirpublic officials to impose and enforce social order.In these countries, reforms based on a partial andlimited analysis of the drivers of corruption can endup further weakening already weak states by furtherlimiting state capacity to act in decisive ways. Thisanalysis does not reject the argument that state le-gitimacy is very important and a state that is actingin arbitrary ways is unlikely to be able to imposesocial order. But the focus of reform and in particu-lar of anti-corruption reform should carefully identifythe major drivers of the problem and take adequatesteps to address the most important problems.

Our discussion of the different drivers of cor-ruption in this section can help to explain the appar-ent paradox that all developing countries appear tohave high levels of corruption and they all fail interms of good governance at early stages of theirdevelopment. We can explain these observations byrecognizing that many of the drivers of corruptionand poor governance (such as weak property rights)are structural and therefore not entirely avoidable inany developing country. Nevertheless, the high-growth countries obviously possessed governancecapacities that allowed them to avoid the most dam-aging aspects of these structural drivers.

Policy Implications

Our analysis suggests that policy based on thegreed plus discretion analysis of corruption is onlyrelevant where the drivers are indeed primarily the

ones identified in these theories. Thus, in cases ofunnecessary red tape and other useless interventionsby the state, where the purpose of the intervention isonly to create opportunities for public officials toextract from society, the conventional policy agendaof liberalization, salary increases, rule of law andtransparency would be very relevant. However, giventhe other drivers of corruption, it is unlikely that thesereforms could be implemented to an extent that anyobservable decline in corruption would follow. Thisis in fact what we observe when these programmesare implemented. However, there is no reason whyunnecessary red tape and other damaging interven-tions should not continue to be targeted and removedin developing countries.

In terms of necessary state interventions, thereform agenda should be quite different. The his-torical observation is that successful states sufferedfrom some corruption in these areas, but they hadstrong state capacities that ensured that the desiredoutcomes were achieved and the cost of corruptionwas not big enough to wipe out the net benefit. Incontrast, less successful states could not performnecessary functions effectively and the corruptionin these areas was therefore extremely damagingbecause they added a rent seeking cost to an alreadypoor outcome. We have argued that the reformagenda in this area should be to strengthen state ca-pacities and legalize and regulate the associated rentseeking.

In the area of political corruption, all develop-ing countries have to endure levels of corruption thatare not desirable in the long run and they have totake active steps to limit this over time by increas-ing fiscal redistributions to maintain political stabilityin a transparent way. However, in the meantime, thereform priority has to be to limit the damage doneby political stabilization through patron-client net-works. In some countries this may mean restructuringthese political arrangements though this is obviouslya discussion that developing countries have to haveinternally.

The instability of property rights and the asso-ciated corruption is also a problem affecting everydeveloping country but high-growth ones clearly hadthe institutional capacities to ensure stable expecta-tions in critical growth areas. The reform priorityfor other countries must be to learn from these ex-periences to develop the necessary governance ca-pacities even though acceptable levels of property


right stability across the board may not be achiev-able for many years.

Finally, predation is the most important risk fordeveloping countries. All successful countries wereable to avoid predation and extortion to any signifi-cant extent because they had strong states that couldlimit the degree to which lower officials or privatelooters in association with local officials could op-erate to the detriment of the state. There are noexamples of rapid and sustained development withstates that lacked the ability to impose social order,but there are many examples of rapid growth in statesthat suffer from some corruption. The critical reformmessage here is (paradoxically) to strengthen stateenforcement capacities in states that are threatenedwith predatory state behaviour rather than to dis-mantle states that are obviously not working.

5. Conclusions

The governance and anti-corruption agenda thatis increasingly championed by international agen-cies like the World Bank identifies critical goals thatall developing countries aspire to. There is no ques-tion about the desirability of good governance. Thequestions raised in this paper are really about:

(i) the extent to which these are not just goals ofdevelopment but also necessary governancepreconditions for development,

(ii) whether they can actually be achieved in de-veloping countries, and

(iii) whether a focus on these governance issues istaking our eye off more important and achiev-

able reforms that will enable the goals of goodgovernance to be achieved faster.

Our analysis seriously questions whether thegovernance agenda can be interpreted as a precon-dition for development rather than being a list ofimportant and desirable objectives. We also arguethat there are strong structural drivers of corruptionand weak property rights that mean that these goalsare unlikely to be achieved to any significant extentin any developing country, regardless of economicperformance. There is a real danger that these struc-tural drivers are not being properly understood. Thedesire to link lending and partnership with develop-ing countries on the basis of small differences ingovernance and corruption indicators is seriouslymisguided according to our analysis. Apart from thesubjectivity of these indicators and the possibilityof manipulation, our argument is that small differ-ences in these indicators tell us nothing at all aboutdevelopment prospects of developing countries.

Instead, we argue that we need to identify criti-cal governance capacities on a country-by-countrybasis to accelerate economic and social transforma-tions in developing countries. We also need a frame-work for distinguishing between types of corruptionso that we can set realistic and feasible national in-stitutional reform priorities and anti-corruption strat-egies. And finally we argue that by focusing on along list of unachievable goals as immediate reformpriorities, we are losing the opportunity to carry outcritical reforms that enhance the chances of devel-oping countries moving from diverging to converg-ing status, or remaining sustainably in the converginggroup once they have enjoyed a growth spurt. Onthe contrary, this reform agenda is in serious dangerof creating disillusionment and reform fatigue as itsgoals are unlikely to be achieved.


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