U4 Helpdesk Query

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• Part I discusses the damaging effects of petty corruption and how they differ from those of grand corruption.
  
• Part II explores links between corruption and shadow economies and provides references for further research.
  

Please also see:

A related Expert Answer, Tackling forms of corruption that hurt the poor most.

U4 helpdesk reply

Petty corruption affects millions of people around the world as they go about their daily lives. It can be particularly burdensome for those with lower incomes. At the same time, these and other vulnerable groups are most likely to be subjected to extortionate demands for bribes and other unofficial payments by the authorities - often to obtain such essential services as water, electricity, benefits, healthcare, etc. Part I of this answer discusses these and other damaging effects of petty corruption. It also contains a section on the contrast between petty and grand corruption.

Discussion of shadow economy as such, with its multitude of economic and socio-political considerations, is out of the scope of this paper. Shadow economy is looked at from the perspective of it relationship with corruption. Part II of the answer discusses the correlation between corruption, including petty corruption, and the shadow economy. It contains references and links to recommended papers on the topic, and indicates who is working on these issues.

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Part I: Petty Corruption

The U4 glossary defines petty corruption as the everyday corruption that takes place at the implementation end of politics, where the public officials meet the public. Petty corruption is bribery in connection with the implementation of existing laws, rules and regulations, and thus is different from "grand" or political corruption. Petty corruption refers to the modest sums of money usually involved, and has also been called "low" and "street" level to indicate the kind of corruption that people can experience in their frequent encounters with public administration and services like hospitals, schools, local licensing authorities, police, taxing authorities and so on.

Unlike grand corruption, which impacts a country by taking large sums of money away from the public purse, petty corruption directly impacts individuals, particularly the poor and vulnerable. It is often just as damaging to the poor, and more immediate and tangible than the bigger corruption cases which make breaking news and scandals.

When discussing the damaging impact of petty corruption, it is also important to remember that petty corruption often takes extortive rather than collusive forms. Bribes are often simply demanded and the non-payment thereof can result in devastating consequences, ranging from the denial of access to essential public services to unjust sentencing and imprisonment. Petty corruption is not only detrimental to development processes but is also a threat to basic human rights (both civil rights such as guarantees of fair trial and justice, as well as socio-economic rights such as access to health, education, and others).

As is often the case with petty corruption, it is not only those who can afford it who are asked to pay, but those who are thought to have no other options. For example, it is estimated that lower income households spend a larger proportion of their income on bribes and find it to be a heavy financial burden. Series of surveys conducted among urban and rural households in Bangladesh, India, Nepal, Pakistan and Sri Lanka (as part of TI's South Asia survey, 2002) sought to measure the incidence of corruption in public services deemed to be of particular importance to the poor such as: healthcare, education, power, land administration, taxation, police and the judiciary. The surveys found that petty corruption was endemic in all sectors in all countries, with bribes imposing a heavy financial burden on South Asian households because of both the high frequency and the amounts paid. For example, in Pakistan, 92% of households using public education services reported the payment of bribes averaging 4,811 rupees (US$ 86) - compared to a gross national per capita income of only US$ 410 per annum.

These are just some of the illustrations of the damaging impact of petty corruption. There are many other facets to the issue. For example, petty corruption is used not only to facilitate access to legitimate services and products but it is also a major vehicle for obtaining fake documentation, permits and licensing. Often modest amounts of bribes to authorities can create safe havens for a myriad of criminal activities and transactions, such as smuggling and trafficking.

Indeed, petty corruption can go as far as threatening national security. In the aftermath of Russia's terrorist acts of 2004, it was revealed that the suicide bombers on two planes from Moscow's Domodedovo airport had evaded security checks by paying bribes of just $30. Meanwhile, after the Beslan tragedy, the newspaper Komsomolskaya Pravda illicitly obtained Moscow registration documents in the name of Maslan Naskhadov, using a photograph of Aslan Maskhadov, the late Chechen separatist leader (see S. Walker, "A Matter of Choice? Corruption as a Social Value or Systemic Constant", September 2005). The article concludes that for almost any procedure there is a parallel structure that offers services - a shadow economy within the overall economy that substitutes the same services quicker but illegally - although often quite openly.

Grand and petty corruption: which is the bigger problem?

Corruption, in its all forms and manifestations has negative ramifications. Grand corruption is considered to be particularly bad for the legitimacy of the government. It can affect country's policy and law making processes, weaken the public institutions and alter country's public spending priorities (for example, by allocating more public spending to lucrative sectors to ensure pay-offs and kick-backs from large public and infrastructure works). It can exhaust country's natural resources and public wealth and hinder business and investment. Petty corruption has equally negative consequences (as listed above), ranging from affecting the livelihoods and the human rights of individuals, particularly the poor and the vulnerable, to facilitating varied forms of criminal activity. So, while the two may affect particular target groups and aspects of a country's governance and development processes to a different degree -- the overall damaging impact of grand or petty corruption is equally serious.

When it comes to public opinion, grand corruption, even if marginally, seems to be rated by surveyed respondents as a bigger problem than petty corruption. TI's Global Corruption Barometer 2004 summarizes the survey results as follows. Across the world, grand or political corruption - corruption at the highest levels of society, by leading elites and major companies - was identified as a very big problem by 57 % of respondents. Fewer (45 %) cited petty or administrative corruption - corruption in ordinary people's daily lives, such as bribes paid for licenses or traffic violations - as a very big problem. Nevertheless, both grand and petty corruption were judged as significant obstacles, with about 8 out of 10 of those surveyed citing them as a very big or fairly big problem in their country.

Petty or administrative corruption was not considered to be an issue in the majority of industrialised countries surveyed, but was especially discounted in Nordic countries and Singapore. Exceptions - where petty corruption was regarded as significant - included France, Greece, Italy, Portugal and Spain, where grand corruption was also considered as grave a problem as in developing countries.

In Brazil, 99% of respondents regarded both petty and grand corruption as very or fairly big problems. The public in Ecuador and Turkey also rated both as significant problems.

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Part II: Petty Corruption and the Shadow Economy

Among researchers who have written extensively on the topic are Simon Johnson, Daniel Kaufmann, and Pablo Zoido-Lobatón. Their findings show that smaller shadow economies appear in countries with higher tax revenues, if achieved by lower tax rates, fewer laws and regulations and less bribery facing enterprises. Countries with a better rule of the law, which is financed by tax revenues, also have smaller shadow economies. Transition countries have higher levels of regulation leading to a significantly higher incidence of bribery, higher effective taxes on official activities and a large discretionary framework of regulations and consequently to a higher shadow economy. Their overall conclusion is that "wealthier countries of the OECD, as well as some in Eastern Europe find themselves in the 'good equilibrium' of relatively low tax and regulatory burden, good rule of law and corruption control, and [relatively] small unofficial economy. By contrast, a number of countries in Latin American and the Former Soviet Union exhibit characteristics consistent with a 'bad equilibrium': tax and regulatory discretion and burden on the firm is high, the rule of law is weak, and there is a high incidence of bribery and a relatively high share of activities in the unofficial economy."

Annotated references and links to papers related to corruption and shadow economy
Dodging the Grabbing Hand: the Determinants of Unofficial Activity in 69 Countries
E. Friedman, S. Johnson, D. Kaufmann and P. Zoido-Lobaton, Journal of Public Economics 76 (2000), pp. 459-493

The research shows that across 69 countries, higher tax rates are associated with less unofficial activity as a percent of GDP, whereas corruption is associated with more unofficial activity. Entrepreneurs go underground not to avoid official taxes but to reduce the burden of bureaucracy and corruption. Dodging the 'grabbing hand' in this way reduces tax revenues as a percent of both official and total GDP. As a result, corrupt governments become small governments and only relatively non-corrupt governments can sustain high tax rates.

Shadow Economy, Rent-Seeking Activities and the Perils of Reinforcement of the Rule of Law
Ekaterina Vostroknutova, Economics Working Papers ECO2003/09, European University Institute, 2003

The study shows that the presence of a shadow sector has different effects in economies with high and low rent-seeking. In an economy with low levels of corruption the direct law enforcement is beneficial for growth, and reduces the shadow sector. However, in a highly corrupt economy, combating the shadow economy reduces output and increases corruption, while combating corruption reduces the shadow economy.

How do Institutions Affect Corruption and the Shadow Economy?
Axel Dreher, Christos Kotsogiannis and Steve McCorriston (Thurgau Institute of Economics, Switzerland, University of Konstanz, Germany, University of Exeter, UK), February 2005

This paper analyzes a simple model that captures the relationship between institutional quality, the shadow economy and corruption. It shows that an improvement in institutional quality reduces the shadow economy and affects the corruption market. The exact relationship between corruption and institutional quality is, however, ambiguous and depends on the relative effectiveness of the institutional quality in the shadow and corruption markets. The predictions of the model are empirically tested by means of Structural Equation Modeling that treats the shadow economy and the corruption market as latent variables using data from OECD countries. The results show that an improvement in institutional quality reduces the shadow economy directly and corruption both directly and indirectly (through its effect on the shadow market).

Investment Climate Reform in Ukraine
Peter Fortune, Private Sector Development Adviser, DFID Ukraine, November 2003

This is a report on issues affecting the investment climate in Ukraine. Amongst the biggest burdens to the climate reported by the surveys are the various inspections, which are often, of course, a vehicle for petty corruption on the part of state officials. In 2002, the average Ukrainian business was inspected 14 times, a figure which has remained static since 1999, although in 1998 and 1997 it was 22 and 30 inspections respectively. The corruption and rent seeking behaviour is stable and the "tariffs" are well-known. Some of it is coercive, but most is collusive. Many Ukrainian entrepreneurs take the view that if they have to pay bribes, they will not pay taxes - more than 60% of the economic activity is in the shadow economy, compared to less than 10% in the UK or US. For poverty reduction, of course, this absence of tax payments into a state budget, which can be used for redistribution, is disastrous.

Corruption's Reflection: Iraq's Shadow Economy
Robert Looney, Strategic Insights, Volume IV, Issue 3, March 2005

The article contains an analysis of the link between Iraq's shadow economy and corruption, drawing on international indicators and data sets that suggest that the size of the shadow economy is largely controlled by factors related to governance. Corruption stands out as the key determinant of the informal segments of the economy, with countries having gained little control over corruption usually having the highest probability of possessing a large informal economy.

The Size of the Shadow Economies of 145 Countries all over the World: First Results over the Period 1999 to 2003
Friedrich Schneider, IZA Discussion Paper series, 2004

Using the DYMIMIC approach, estimates of the shadow economy in 145 developing, transition, developed OECD countries, South Pacific islands and still communist countries are presented. The average size of the shadow economy (in percent of official GDP) over 2002/2003 in developing countries is 39.1%, in transition countries 40.1%, in OECD countries 16.3%, South Pacific islands 33.4% and 4 remaining Communist countries 21.8%. An increasing burden of taxation, high unemployment and low official GDP growth are the driving forces of the shadow economy.

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