Corruption, once useful, has no place today in China's aspiring market economy

Paolo Mauro says though corruption arguably eased China's economic transition, it's no longer the case

PUBLISHED : Wednesday, 16 September, 2015, 5:33pm
UPDATED : Wednesday, 16 September, 2015, 5:33pm

When political scientists argue that corruption can sometimes help an economy grow, they have in mind a country like China. In an economy where several sectors are still shackled by pervasive regulations and controls, the payment of bribes in exchange for government permits can sometimes restore some semblance of a free market.

Indeed, while corruption is generally harmful to economic growth, there is a case to be made that in the years since China launched its transition to a market economy in the late 1970s, it was a necessary evil because of the country's unique initial circumstances: rigid state control and limited international trade.

Today, however, President Xi Jinping's drive against corruption is prompting a reconsideration of the impact of graft on the Chinese economy. In view of the country's economic transformation and integration into the world economy, curbing corruption has now become ever more necessary to sustain high economic growth.

Most economists who have analysed the effects of corruption have found it to be detrimental to growth. In the first cross-country empirical study to examine this question, published 20 years ago, I showed that higher perceived corruption (based on surveys of investors) led to slower economic growth, in large part through lower rates of private investment. There was no link, however, in the cross-country data between corruption and declining public investment, perhaps because large infrastructure projects create ample opportunities for bribes.

China's primary political challenge in the near future will be to convince government officials to accept a growing entrepreneurial class richer than they are

Those results have been replicated by many researchers and corroborated by multiple studies based on different samples and techniques. Early work, including mine, was based on investor perceptions in the early 1980s, and was thus focused on market economies (understandably, the consulting firm that surveyed perceptions at the time did not analyse communist countries).

In any case, China, with its breakneck economic growth combined with perceptions of widespread corruption, has remained a gigantic outlier.

Two distinguishing features of the Chinese economy help explain why it has seemed able to swim successfully against the current. First, China's rapid economic growth has been fuelled by unusually large public investment, which, consistent with my own research, does not seem to be adversely affected by corruption. Second, China's strictly controlled society has given rise to well-organised corruption, which - as economists Andrei Shleifer and Robert Vishny argued in the early 1990s - is surely less harmful than the chaotic corruption experienced by, for example, the ex-Soviet countries during their early years of transition.

In China, entrepreneurs know who to bribe and how much to pay, and they can be reasonably confident that, in exchange, they will be able to undertake their investment. In contrast, when corruption is chaotic, entrepreneurs face greater uncertainty: paying a bribe to one official is no guarantee that other officials will not demand a pay-off as well.

There is little doubt, however, that corruption has been rampant in China. In addition to the collection of bribes and the sale of promotions in the army and government, investigative journalists have documented that senior officials in China - as in many other countries - hold sizeable stakes in valuable companies (often through relatives and friends). Interestingly, the value of these companies may well have risen once the rumour spread that powerful officials had become associated with them.

It is conceivable that, without corruption and cronyism, China's progress towards a market economy would not have been politically sustainable. By allowing government officials to have a stake in the country's economic growth, it became easier to liberalise the economy and to open the doors to international trade, one of the keys to China's economic success.

But, as China has grown into a more internationally integrated, modern economy, pervasive corruption has become more harmful than beneficial. The leadership may have come to the conclusion that, from the standpoint of political sustainability (and discounting the possibility of internecine power struggles), too many government officials among the "haves" would alienate "have-not" ordinary citizens.

From an economic standpoint, with China increasingly exposed to the discipline of international trade and facing an economic slowdown, the argument for reining in corruption is as strong as ever. As my colleague Nicholas Lardy's convincing analysis has shown, China's economic performance has been increasingly market-driven, rather than state-driven, and private firms will provide the major source of growth in the years ahead. But this requires that the private sector be unimpeded by corruption.

Unfortunately, high-profile arrests like those carried out in China in recent years are insufficient to curb corruption in a lasting manner. Reducing pervasive government intervention in the economy and encouraging greater competition would reduce the near-monopolistic rents that create the incentives for corruption in the first place. This will require cutting red tape and deregulating the economy.

China's primary political challenge in the near future will be to convince government officials to accept a growing entrepreneurial class richer than they are, while continuing to reform the economy and to foster the development of the private sector.

Paolo Mauro is a senior fellow at the Peterson Institute for International Economics. Copyright: Project Syndicate