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Greasing Palms: Corruption in Mexico

What effect does corruption have on Mexico’s ability to lure important foreign investment?

June 27, 2005

What effect does corruption have on Mexico's ability to lure important foreign investment?

Four hours after departing lovely Morelia, a town in the Mexican highlands, we were in the middle of rush hour traffic in Mexico City, trying to reach the airport, return our rental car — and catch our flight home.

My wife, a true wiz at map reading, had got us nearly there when one of the many traffic policemen near the airport ordered us to the curb.

There he told us that we had violated two laws — one of them the speed limit, which would have been physically impossible to violate in that bumper-to-bumper traffic — and that he would confiscate my driver’s license.

In case we doubted him, he produced a stack of confiscated driver’s licenses for my consideration. With our poor Spanish, we were no match for him, and after several minutes of futile efforts, we gave him five $20 bills, which he pocketed while walking away, waving us on.

It is hard to view such an experience as many businessmen are said to view corruption: bribery is just another cost of doing business. Evidently, the costs of renting a car should have included $100-$200 for bribing policemen.

My wife and I, however, are not a business. We do not have “fixers” employed to negotiate “side payments.” Neither do we have budget lines to accommodate the expenditures. For visitors coping on their own with corrupt officials, the effect of corruption goes beyond the monetary cost. Being pushed around by a corrupt official is similar to being robbed. It is not easy to be analytical when one is being violated.

Now, as a development economist, I am familiar with the argument that corruption is not a significant drag on an economy and that it might even accelerate economic growth by “greasing the wheels” of bureaucracy. But that train of thought is out of step with the evidence.

In a series of papers, Shang-Jin Wei, formerly of the Kennedy School at Harvard and now with the IMF, explored the economic effect of corruption. Contrary to the notion that corruption is a relatively minor cost of doing business, Wei found that corruption has a stifling effect on foreign investment and economic growth.

Since Wei’s estimating method also accounted for the effect of other determinants of foreign investment — like taxation of business income, political stability, average income, population and remoteness of a host country — Wei could put the effect of corruption in the context of the effect of other determinants of investment.

Wei found that reducing the level of corruption from the Mexican level to that in Singapore would have the same effect on foreign investment as reducing the tax on capital income by 50 percentage points. In other words, corruption reduces foreign investment as much as a tax that takes half of net income!

This does not mean that corruption in Mexico in fact does take half of net income. Wei showed in another paper that unpredictable corruption is more harmful than routine corruption with a steady cost. Part of the stifling effect of corruption on the economy comes through the uncertainty and insecurity it forces on businesses, above and beyond the financial cost.

It is easy to imagine how the frustration and feeling of helplessness that my wife and I felt in the face of the corrupt police officer would discourage international business from entering Mexico.

Just how bad is corruption in Mexico to have such a large effect on foreign investment? The figure below shows the most recent results of the annual survey by Transparency International, a group that monitors corruption worldwide. (The figure shows the results for only 10 of the 146 countries with corruption ratings.)

Corruption Perception (Selected Countries)
Data Source: Transparency International

Mexico is far from the most corrupt country in this sample. Indeed, the rapidly growing giant economies of China and India are more corrupt than Mexico. But the ubiquity of corruption does not make it any less costly to low-income countries.

Once embedded in the economic practices of a country, corruption is enormously difficult to remove. That is not because people are necessarily more tolerant or forgiving of corruption in a country where it is common than where it is rare.

My own friends in Mexico and Bangladesh are angry and bitter at the corrupt practices that make their lives difficult too. Who suffers when valuables cannot be sent through the mail and when insider connections and side payments are the way to get routine public services? Ordinary citizens suffer.

Yet, the very people who decry corruption may practice corruption. The only honest man in an office full of corrupt officials may die with a clear conscience, but he will die in the same corrupt country as the official who “went along with the crowd.” And the honest man will die poorer than any of his colleagues.

Corruption creates a “prisoners’ dilemma.” If everyone becomes honest, everyone will be better off. But if some people are taking bribes, then there is a strong incentive for his colleagues to follow until everyone is corrupt. And then, how does one get to the more desirable situation where nobody is corrupt?

This is not an easy question. As Robert Putnam, a professor of public policy at Harvard University, has shown for the regions of Italy, differing traditions of corruption can persist for decades, even centuries.

These are problems that require change from within the culture that suffers corruption. In Mexico, some communities are recruiting women police officers in the hope that the change will promote honesty.

Some communities announce crackdowns on corruption. But these rarely are successful because too many people in power have themselves practiced corruption. The oddballs who refused to go along were marginalized long ago.

Even revolutions with new leaders and new idealist rhetoric often only bring temporary relief.

Despite all this depressing news, I am ultimately an optimist. Most of the countries that today suffer high levels of corruption still are growing well, with rising incomes and rising levels of education.

In the end, most countries will muddle through, as the industrialized countries have done over the course of the last 200 years.

They did set the example that it is possible to evolve from undemocratic, corruption-plagued systems to less corrupt places where people to go to the police for help — instead of hiding when they see a policeman.