This article is based on a lecture by Linda Lim sponsored by the Center for Southeast Asian Studies at the International Institute on October 25, 2002. The lecture included material from a literature review by Linda Lim and Aaron Stern published, in Asia-Pacific Economic Literature (citation). The review focused on five market-economy countries of Southeast Asia—Indonesia, Malaysia, Philippines, Singapore and Thailand—and primarily on literature of the 1990s. Lim is a professor of corporate strategy and international business in the U-M Business School and an associate director of the II.

    Southeast Asia is distinctive in many ways, and this is no different with respect to the much studied subject of corruption. Indonesia, Philippines and Thailand have ranked among the most corrupt countries in the world by all the existing indices, for the past 30-40 years. Together with China, they are certainly the most corrupt among countries that have attracted substantial amounts of foreign investment in this time period.

    Indonesia and Thailand have also ranked among the fastest-growing economies in the world in the past, as they still are today (largely because nearly everyone else is in stagnation making four to five percent annual growth rather respectable, behind only China and South Korea). This challenges the prevailing belief (and empirical evidence) that corruption discourages investment and hurts the economy, so that countries with corrupt governments won‘t experience economic growth.

    Indonesia, the Philippines and Thailand have all recently democratized—the Philippines as long ago as 1986—yet there has been no discernible drop in corruption; in fact, there may have been some increase in corruption following democratization, though with some changes in its perpetrators and beneficiaries. By some indices, in the 1990s all three countries even fell from being less to being more corrupt than China. The least democratic of the five market-economy countries, Malaysia and Singapore, are also ranked as the least corrupt.

    All these countries have experienced economic liberalization—the reduction of trade and investment barriers, and less government intervention in the economy—which is supposed to reduce corruption because businesses no longer need to pay bribes to be allowed to conduct their business. Yet despite this, there has been no discernible fall in corruption.

    Corruption and Growth

    The puzzle that the literature is most concerned with is the positive relationship between corruption and growth in Southeast Asia, i.e. high corruption has been accompanied by high growth and vice versa.

    The most common explanation is that strong central state authority is associated with lower corruption than in decentralized polities. A single monopoly bribe-taker is more likely to make sure that his revenues are maximized without hurting economic growth, i.e. he doesn‘t want to kill the goose that lays the golden egg.

    Andrew McIntyre has used this argument—the Shleifer-Vishny theoretical framework—to explain Indonesia‘s good economic performance under the corrupt Suharto regime. Michael Ross adds that if the highly centralized state authority is secure in its power, it will exploit natural resource rents under its control less rapidly than if it is politically insecure. He thus explains why forest exploitation by state authorities has been more rapacious under decentralized state authorities in democratic governments in the Philippines, than under the heavily centralized early Marcos dictatorship, and why Marcos himself became more rapacious as he grew more politically insecure.

    This argument could also explain why Malaysia and Singapore, with the most centralized and powerful state authorities, are least corrupt. It predicts that when a polity democratizes and decentralizes, the appearance of many competing bribe takers increases the rake-off from business and the population at large, and stalls economic growth. Thus, democratic Thailand since 1991 and democratic Indonesia since 1998 have experienced both slower economic growth and perhaps greater corruption than under their preceding authoritarian regimes.

    A second explanation in the literature for the positive correlation between corruption and growth is that Asian countries—China, Taiwan and South Korea as well as Southeast Asia and even India—have managed to grow because their corruption is predictable. What discourages business investment (necessary for output growth) is not so much corruption per se as uncertainty and unpredictability. If corruption is predictable and stable you can factor it into your business cost calculations—it reduces but does not eliminate your profit margin. A quote from a multinational executive interviewed in Jakarta last year illustrates this point:

    In the past, under Golkar [Suharto‘s political party], we always knew whom to pay, and how much, and always got what we paid for. Now, for a single (policy) decision, all kinds of different groups clamor for payment. We don‘t know who they are, or whether they can really deliver—sometimes they don‘t deliver, and even if they do, we have to pay much more in total than we did before. And we risk being caught by the anti-corruption authorities [who themselves may be in search of bribes].

    A third explanation for the coexistence of corruption and growth is argued by Rick Doner, Ansil Ramsay and others, thus: Where the state acts as patron distributing favors to business, a situation of “competitive clientilism,” where many firms compete for the state‘s favors, is more economically efficient than one of “monopoly clientilism,” where only a previously favored crony gets the favor. Thus, Thailand under military regimes was characterized by “competitive clientilism,” under which more efficient firms were better able to pay bribes in exchange for government favors and still remain profitable, whereas the Philippines under Marcos was characterized by “monopoly clientilism” with specific cronies being favored. Not only did Thailand experience higher economic growth, but Doner and Ramsay also argue that the automobile industry that developed there was also more efficient and viable than that which developed in the Philippines.

    Beyond the cited literature, many other explanations for the corruption-growth linkage are plausible, but all have some shortcomings. For example, here‘s an argument why corruption might lead to higher growth, the opposite of the conventional wisdom. Developing country economies tend to have lots of inefficient government regulation and state intervention, imperfect markets and imperfect information, etc. The transactions costs of doing business are thus high and discourage investment and hence economic growth. Corruption helps business to get around these barriers and difficulties and still do their business. But what is unexplained is why only business in Asia (Southeast Asia, Korea and China) functions in this way, and not that in other developing countries.

    Another argument is that it is growth that leads to corruption and not vice versa. Growth creates huge profits from which greedy government officials then seek a share, especially in authoritarian countries where they can simply shut down businesses which refuse to cooperate. But we don‘t see this happening everywhere, and in Singapore, for example, increased growth did not lead to more corruption. Rich countries also tend to be less corrupt than poor ones.

    One can also argue that growth and corruption have separate roots, which are unrelated. For example, as in Malaysia, growth could come from a separate multinational-dominated export sector which is untouched by corruption because government officials understand and accept the need to keep costs low to be internationally competitive—e.g. labor-intensive export manufacturing industry is subject to the discipline of international markets and cannot afford the higher costs associated with corruption. Corruption may continue in the domestic sector, which is protected from import competition. But this argument also has its weaknesses, e.g. the economic segregation of domestic and export sectors is rarely easy or complete.

    Finally, Southeast Asia‘s local private sector—which is the most heavily “taxed” by corruption—is heavily ethnic Chinese, a politically vulnerable minority, which may be very efficient and entrepreneurial and willing to invest, but also forced to pay bribes to government officials in order to be allowed to do so. This may explain high corruption, but it is not sufficient to explain high growth, especially since fast-growing territories in which ethnic Chinese are the majority, e.g. Taiwan, also suffer from high corruption, as do other slower-growing but also corrupt developing countries where other minorities dominate the private sector.

    The second puzzle is the relationship of democracy and corruption. These are all relatively new democracies but in established market or mixed economies, unlike the formerly socialist transitional economies in Eastern Europe. Yet the advent of democracy has not (yet) led to a decline in corruption, and in some respects and cases it may even have increased with democratization.

    Democracy and Corruption

    One obvious reason is that running for election costs money, especially in low income countries, but even in the rich United States this is the case. Those who can afford to run for government, and have the incentive to do so because policy can directly affect their business interests, are overwhelmingly from the business community. If candidates are not in business themselves, they need to secure financial support, which must come from business, which will contribute only if they expect something in return (just like in the US). Thus, you end up with rich or beholden people in government. The prime minister of Thailand, Thaksin Shinawatra, elected by a large and historic majority vote, is the country‘s richest individual, who rose from the police force to become a business tycoon in the heavily regulated telecoms sector. Other less wealthy candidates still have to pay off their supporters after election. In Malaysia, political parties solved this problem by going into business themselves—UMNO, MCA and MIC all run some of the biggest business conglomerates in the country, using their political position to earn large profits part of which are plowed back into electoral campaigns to maintain their political position.

    A second reason why democracy might increase corruption is that, especially following on a heavily-centralized previous authoritarian state, power tends to devolve to localities through the process of decentralization or, as it is called in Indonesia today, “regional autonomy.” In Thailand and the Philippines, scholars like Sidel, Pasuk and others have shown that political decentralization leads to the rise of “local bosses” or “godfathers” (chao poh in Thailand) who manage to both accumulate wealth and dispense favors, influencing the parliamentary representation from their districts or provinces. It‘s easier for a local businessman or government official to exert power on the local stage where there is less competition than nationally. In Indonesia as in China, investors complain about lots of “hidden taxes” imposed by local authorities. This is one reason why some observers have welcomed the election of Thaksin (who was accused of corruption himself) and his moves toward re-centralization of power and de-democratization—because they believe a la Shleifer and Vishny that it could reduce overall corruption and reduce the power of the regional godfathers.

    What is the role of multinationals?

    Conventional wisdom in the academic and policy literature, with some empirical evidence from large-n cross-country studies, is that lower corruption helps to attract foreign investment, and that foreign investment itself, especially in the financial sector, will reduce corruption by increasing competition, improving transparency and accountability, and because foreigners (who can go anywhere) are under less pressure to give bribes and kickbacks. Local firms are less competitive, more reliant on government protection and subsidies, more vulnerable to political and social pressure, and with fewer alternative outlets for their money.

    Note, however, that most of the foreign investment in Southeast Asia comes from Northeast Asia (Japan, Korea, Taiwan and Hong Kong; now China is getting to be a big investor) as well as from regional neighbors, chiefly Singapore, then Malaysia. These investing nations tend to be less corrupt than the Southeast Asian countries, but also more corrupt than most Western nations (according to Western indices of perceived corruption).

    But during the Suharto years in Indonesia, a wide range of blue-chip, name-brand multinationals of many nationalities—Western as well as Asian—merrily invested in joint ventures with Suharto‘s children and cronies. They included companies like Merrill Lynch, Morgan Stanley, GE, Lucent, BP, Siemens, Mitsubishi, Sumitomo and Hyundai. Typically they would give some equity (e.g. 25 percent) free to one of the children, who wouldn‘t even have to contract to perform any favors in exchange. The connection alone was sufficient to smooth the way.

    One China consultant told me that what he calls “the Indonesian model” is now being followed in China, though more discreetly, with the so-called “red princes and princesses,” children of high-level party leaders and cadres, being eagerly hired by foreign consulting firms and investment banks, for the business they expect to be (and is) thrown their way due to these “connections.”

    This practice is not peculiar to China. International consulting firms and investment banks have been known to hire the children of political leaders or highly-placed civil servants in Southeast Asia as well. A former student working for a name-brand American consulting firm told me that they didn‘t have big contracts in Malaysia because another foreign competitor had the connection with Petronas, the state oil company which funds many government contracts. But the company did have big contracts with government-linked entities in Singapore and the Philippines because its principals in both countries were well-connected with political leaders there. These are the very companies that claim to be able to help Southeast Asian governments and companies become more efficient, transparent, accountable, etc. etc.

    But perhaps this should not be a surprise. Ever since the election of President Bush, Southeast Asians have been having a field day enjoying the fact that “Americans cannot lecture us about democracy any more,” referring to the extraordinary circumstances of his election (the son of a former president who won on the basis of a controversial vote in the state governed by his brother—“Why, it‘s just like here,” was a common comment). With the Bush administration‘s incredible recent trade protectionism—high steel tariffs and especially huge agricultural subsidies which will hurt Southeast Asian farmers—they have added, “Americans cannot lecture us about free markets any more either.”

    With the Enron and other corporate scandals, “Americans cannot lecture us about corruption, transparency, accountability any more,” and with the homeland security actions and the anti-terror war, “Americans cannot lecture us about human rights any more.”

    Stern is a doctoral candidate in political science working on doctoral research in Thailand.