Corruption: The Boom and Bust of East Asia

Corruption: The Boom and Bust of EastAsia Governance and corruption have finalJy come to the fore of the development debate. While interest in governance began to surge in the earl)' 1990s, the East Asian crisis has catapulted the issue to prominence. Analysts and academics. in a spate of anides and books, have added their voices to the chon.s of criticism of the so-called Asian miracle. Their verdict: Bad governance and corruption did the "miracle" countries in. Taking a different perspective. this book asks and attempts to answer how these countries were able

10

attract enormous amounts of

investment and enjoy rapid growth (lver a thirty-year period despite being perceived as hotbeds of corruption As convelllional wisdom would have it. high rates of investment are inconsistent with high levels of corruption. While this may be true in general. the chapters in this volume suggest that we need to look illlO the nature of corruption. Different types of corruption have varying effects On investment.

I. Edgardo Call1IJOS is senior economist in the Strategy Policy Depanment of the Asian Development Bank. I/a-/ooll Clumg is professor at the Faculty of Economics and Politics, Cambridge University. Emmalluel S. de Dios is professor in the School of Economics. University of the Philippines. Hadi Salehi Bfaltalli is professor in the Department of Economics. University of Illinois

at

Urbana-Champaign.

Allell Hickell is assistant professor at the Depanment of Political Science, University of Michigan. lie was previously assistant professor at the Gra(lllatc School of International Relations and Pacific Studies. Departmelll of Political Science, University of California at San Diego. lomo K. S. is professor in lhe Department of Applied Economics, University of Malaya. SI.llhe Li is associate professor in the Depanmelll of Economics and Finance. City University of Iiong Kong. Peng Ua/l is director of Stalistical Research and Analysis. Nllmetrics Management Systems. Santa Clara. California. DO/lflld Lien is professor of economics and finance at the Umvcrsity of Texas at San Antonio. AlLdrew Macilltyre is professor in the Graduate School of International Relations and Pacific Studies, Departmcnt of Political Science. University of California at San Diego. SalLjay PradlulII is senior governance advisor for the South Asia Region at the World Bank.

Ateneo de Manila University Press Kallpunan Avenue. Loyola His Q.C. P.O. Box 154, 1099. Manila .•

9 ISBN 971-550-377-2

CORRUPTION THE BOOM AND BUST OF EAST AsIA

Edited by

J. EDGARDO CAMPos

ATENEO DE MANILA UNIVERSITY PRESS

-

ACKNOWLEDGMENTS

We gratefully acknowledge the financial support of the Foundation

ATENEO DE MANIlA UNIVERSITY PRESS Bellarmine Hall. Katipunan Avenue Loyola Heights. Quezon City

for Advanced Study i n International Develop ment (FASI D ) of Japan and

P.O. Box

the World Bank Institute (WBI) for this manuscript. Special thanks go to

Tel.:

154. 1099 Manila. Philippines (632) 426-59-84 I FAX: (632) 426-59-09

D a n ny Leipziger, fo rmer C h ief o f the Regulatory Refo r m and P r ivate

E-mail: [email protected]

Sector Develo p ment Division of the WBI; Farrukh Iqbal, former East Asia Regi o n al C o o rd i n a t o r fo r the WBI; and M i c h i k o Kakegawa, Program Copyright

2001

Officer for FASID, under whose watch the various research p apers were

by Ateneo de Manila University and J. Edgardo Campos

initiated, and to B rian Levy and Stephan H aggard for their constructive

Cover and book design by J. B. de la Pena

criticisms of the initial drafts of the chapter p apers. We also wish to thank

All rights reserved.No part of this publication may be reproduced. stored in a

participants of the Fifteenth WB IIFASI D Joint Seminar on G overnance

retneval system. or transmitted in any form or by any means. electronic mechanical

;

photocopying. recording. or otherwise. without the written permission of he Publisher

:

and Private I nvestment i n East Asia for their comments and suggestions o n the revised versi o n s o f the chapter papers, H annah M o o re fo r her patient editing of the penultimate version, Alice W. Y. Chan and Rebecca

The National Library of the Philippines CIP Data Corruption: the boom and bust of East Asia I edited by J. Edgardo Campos; with contributions

from Ha-Joon Chang . ..

ADMU Press. c2001

I

et al.

J

- Quezon City:

1 v.

I.

Financial crises - East Asia.

2. East Asia -

Economic conditions. 3. East Asia - Politics and

government - Corrupt practices. I. Campos. J. Edgardo. II. Chang. Ha-Joon. HB3722 332 2001 ISBN 971-550-377-2

POI 1000025

H i fe fo r their research a s s i s tance, D an iele Evans fo r her p a i n s taking effo rts at organizing the works h o p s at which earlier drafts were p re ­ sented and discussed, and Flor Guce fo r making sure the final version co nfo rmed to publicatio n guidelines .

.,.

CONTENTS

INTRODUCTION

]. Edgardo Campos

1

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1

CORRUPTION AND I TS IMPLICATIONS FOR INVESTMENT ]. Edgardo Campos, Donald Lien, and Sanjay Pradhan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1

2 INVESTMENT, PROPERTY RIGHTS, AND CORRUPTION IN INDONESIA Andrew MacIntyre

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

25

3 STATE, CAPITAL, AND INVESTMENTS IN KOREA Ha-]oon Chang

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

45

4 GOVERNANCE AND INVESTMENT IN CHINA Shuhe Li and Peng Lian

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

69

5 CENTRALIZATION, POLITICAL TURNOVER, AND INVESTMENT IN THE PHILIPPINES Emmanuel S. de Dios and Hadi Salehi Esfahani

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

101

6 GOVERNANCE, RENT-SEEKING, AND PRIVATE INVESTMENT I N MALAYSIA ]omo K. S

.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

131

7 GOVERNANCE AND GROWrH IN THAIlAND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

163

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

183

Allen Hicken NOTES

REFERENCES INDEX

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

198 215

INTRODUCTION ]. Edgardo Campos

In this d ay and age, it has become fashionable to talk ab out "go o d governance" a n d i t s importance in stimulating a n d sustaining economic growth. The current heightened interest i n this subject has been stimu­ lated by the enhanced cap acity o f economists and political scientists to m o del m o re rigorously the incentive dynamics within different gover­ nance structures , to quantify the quality of governance, and to measure its impact on economic performance (see, for instance, Kaufmann 1 996, Urata and Kawai 1 99 9 , M auro 1 99 5) . The East Asian financial crisis has heightened the concern not o nly over g o o d governance b u t also over the rel a t i o n s h i p between gove r ­ nance a n d corruption. M any critics of the Asian miracle have argued that the governance structures underpinning the East Asian economies have been largely responsible fo r the crisis. I nterestingly, however, the quan­ titative indices that have been used to rank countries in terms of corrup ­ tion, and more generally rule of law, either did not change much before and after the crisis set in or changed in an "unexpected" direction.! China and I n d o nesia, fo r example, had always been ranked among the m o st co rrupt countries in the world, followed n o t too far down by Thailand and the Philippines . Before the crisis , M alaysia was always ranked among those with better rule o f law. The term "go o d governance" is s o mewhat slip pery and ambiguous as numerous defi n i t i o n s permeate the l i t e rature. Wh ateve r the defi n i ­ t i o n , t h e r e a p p e a r s t o b e a c o n s e n s u s t h a t g o o d gove r n a n c e m u s t

necessarily encompass the protection of property rights. This h a s led to the c o rollary that credible c o ntract enforcement is necessary to attract

Introduction

Introduction

productive inve stments and thus stimulate e c o n o m i c growth. I n d e e d,

is o n the one hand a manifestation o f institutional inertia in the midst

there is n o w r e a s o n a b l e e m p irical evi d e n c e that s u p p o rts this t h e s i s

of a rapidly changing e nvironment, and o n the other a commentary on

( s e e , fo r instance, Keefe r and K n a c k 1995) .

the problems o f transition to a s o ciety gove r n e d by the rule of law.

Implicit in much of the literature on p rivate p r o p e rty rights is the assumption that formal legal institutions, such as an independent judi­

The East Asian Paradox

ciary, are critical to the credible enforcement of c ontracts (see, for instance,

The experience of the six countries presented in this volume-China,

North and Weingast 1 98 9 ; North 1990) and hence for stimulating invest­

Indonesi a, Korea, M alaysia, Philippines, and Thailand-p resents a dif­

ment and growth.2 While not denying the importance of such institutions,

ficult p aradox t o p r o p o nents o f "go o d governance." O n the one hand,

this volume questions the almost theological belief that countries with­

these countries h ave managed t o attract large flows o f p rivate i nvest­

out s u c h i n s t i tu t i o n s are d e s t i n e d to r e m a i n p o o r and e c o n o m i c ally

ment over a very long period (although the Philippines was a latecomer) .

u n d e rdeve l o p e d . To be s u re, i t d o e s not challenge the validity o f the

On the other, with the exception of Malaysia, these countries have fea­

Northian thesis: as many historians have shown, over the very long haul,

tured p r o m i n e n t l y i n t h e " w o r l d 's l i s t" o f m o s t c o r r u p t c o u n t r i e s .3

an economy will eventually stagnate if institutions that promote the rule

More ove r, as c o nventional wis d o m would have it, c o rrup t i o n in these

of law fail to develop. The volume, however, does raise the issue of what

countries is h ighly c orrelated with a perceived weakne s s o f legal insti­

happens in the interim between now and the almost invisible long-term

tutions. Hence, the proponents of "goo d governance" are confronted with

ho rizo n . For b u s i n e s s m e n and p o l icy makers i n develo ping c ountries,

exactly t h e o p p o s i t e of t h e i r rev e r e d g o s p e l : in E a s t Asia, weak l e gal

the No rthian prescription is of little utility as they, their childre n, and

institutions have existed side by side with high levels of investment (not

p e rhaps even their grandchildren will have b e e n d e ad by the time the

t o mention rapid rates o f growth) .

rule of law emerges i n their countries.

The volume attempts to resolve this p aradox. I n different ways, a

East Asia's experience over the p ast thirty years provides a window

number of the autho rs argue that institutions that promote the credible

into the labyrinth between the "now" and North's long haul. As the case

enforcement of contracts have indeed existed in many of these East Asian

studies in this volume maintain, in East Asia info rmal, nonlegal arrange­

countries. These institutions, however, are of the informal, nonlegal variety

ments emerged (over a relatively short period of time) to fill the formal

which the above proponents often perceive (and believe) to be detrimen­

institutional vacuum. These institutions made contracts enfo rceable and

tal t o e c o n o m i c growth b e c a u s e they p r o p agate r e n t - s e e k i n g and

thus encouraged inflows of private (and productive) investment. Indeed,

consequent large- scale corruption. Their assumption is that if institutions

there is now a m o u ntain of evidence indicating large fl ows of p rivate

foster rent-seeking and corruption, then they must be inimical to growth .

investment into East Asia, both domestic and foreign, despite the weak­

By contrast, the authors argue that rents and corruption have been essen­

ness o r even absence of legal institu t i o n s .

tial to the credible enforcement of contracts and thus to the large inflows

T h e A s i a n e c o n o mic c r i s i s h a s brought gove rnance and t h e r u l e o f

of investment. In his chapter on Indonesia, M acintyre makes this p o int

l a w i n t o t h e fo refront o f d i s c u s s i o n s and d e b a t e s about the s o - called

most crisply and vividly. He maintains that special features of the Suharto

Asian M i racle . The c r i s i s, many critics o f the miracle argue, e r u p t e d

regime had allowed it to function much like a joint monopolist trying to

b e c a u s e o f p e rvasive, institutionalized c o rrupti o n made p o s s ible by a

maximize profits across complementary products. Specifically, he argues

dysfunctional, politically malleable legal system. The resulting calls fo r

that Suharto established and nurtured a political structure grounded on

institutional reform have b e e n deafening.

two pillars, corruption and investment. The structure gave Suharto ample

These critics, howeve r, have lost sight of the obvious fact that thirty

opportunity to extract rents, to distribute it systematically across the bu­

years of i m p r e s s ive, ext e n s ively d o c u m e n t e d e c o n o mi c p e rfo r m a n c e

reaucratic and p olitical landscape, and to keep the costs of generating the

p r e c e d e d t h e crisis. T h i s v o l u m e attempts to a d d r e s s t h i s s e e ming d i ­

rents from squeezing out long- term investments. A conscious decision to

choto my. To be sure, t h e volume d o e s not purport to b e another treatise

open the capital account early in the regime's life effectively tied Suharto's

on the crisis. Rathe r, it situates the crisis within the larger c o ntext o f

hands and credibly committed his regime to honoring agreements with

institutional change. A s many of t h e authors argue o r imply, t h e crisis

investors: investors could take their money out if they sensed any u nfa-

2

3

Introduction

Introduction

vorable change in economic policies. Hence, Suharto and his regime had

exchange for investing in pro ductive , exp o rt- oriented activities, (3) p r o ­

strong incentives to ascertain that private investors were not subj ected to

vided implicit ( a n d illegal) wages to relatively poorly p a i d p u b l i c official s ,

independent, uncoordinated rent- seeking, bribe-taking efforts that discour­

(4) provided discretionary funds to lo cal p oliticians to e n a b l e t h e m t o

aged long- term investments. I n sum, while investors might have had to

b u y p olitical s u p p o rt , and (5) l i m i t e d c o rruption flows to s e c t o r s that

fork out considerable rents, whether in the form of bribes or shares, they

were less important fo r international comp etitiveness . Like its counter­

were assured that their investments would be protected from harassment

parts in Indonesia and China, this tightly knit, relatively well- thought-out

and that agreements they had made with the government were adhered

system was glued together by rents and corrupti o n .

to. The rents and associated corruption involved have been the glue that has tied this info rmal sys tem together and has made the system work effectively over thirty years .

Institutional Change and the East Asian Crisis

Highly authoritarian regimes have governed each of the three coun­

Similarly, Li a n d Lian c o nt e n d that the p ol i t i c a l regime in C h i n a

tries discussed above . One is thus tempted to deduce that demo cratizing

b e h aves much l i k e a "j oint monop olist." T h e y present an abstract sys­

these regimes will improve governance and reduce corruption. Economic

tem which they label marke t - p re s e rving authoritarianism ( M PA) , argue

historians indicate that over the long haul this is likely to b e the case.

that China fits this abstraction reasonably well, and then conclude that

Yet if world history is any guide, the transition period is likely to be very

the b a s i c fe ature s of an M PA h ave l e d to a b al a n c e b e tween p olitical

long. And in the transiti o n , things may n o t get b etter until much later.

centralization and economic decentralization that ultimately places con­

De Dio s's and E s fahan i 's study on the Philippines identifies a fun ­

straints o n corruption in order to attract p rivate investment. Among the

d a m e n t a l d i l e m m a t h a t m a y c o n fr o n t c o u nt r i e s u n d e r g o i n g s u c h a

more concrete, China - sp ecific features of an M PA, they identify a set o f

transition. Democratization tends to distribute p ower and political influ ­

internal r u l e s governing recruitment, p r o m o t i o n , and b e h avior within

ence more widely acro s s different group s . This creates more s o - called

the bureaucracy, an economic p e rforman c e - b as e d system of promotion

veto p o i n t s i n t h e d e c i s i o n - making p r o c e s s a n d p o t e n t i ally leads t o

within the Communist Party, collective decision- making mechanisms that

gridlock. I n t h e absence of firmly established demo cratic instituti o n s , it

increase transparency i n the p r oj ect- approval p r o c e s s , a graduated al­

leads to what Shleifer and Vishny ( 1993) call an "independent mono p o ­

l o c a t i o n of c o n t r o l or a u t h o r i t y a t v e r t i c a l l e v e l s o f p u b l i c - s e c t o r

l i s t " regime of rent- seeking a n d corruption that s i gnific antly increases

management-meaning that lowe r - l evel o fficials h ave explicit limits to

transactions costs (including rent- se eking costs and associated levels of

what is within their authority, fiscal decentralization, and a court system,

corruptio n) . A natural , al m o s t knee-j erk response to this has been to

which, while cle arly weak and inadequate, renders imp artial j udgment

maintain a strong executive branch of government, as this is viewed as

in cases where the verdict can b e easily verified by a third p arty.4 Com­

a way to prevent gridlock and keep transactions costs from bursting at

bined with the exi s t e n c e of a large ove r s e a s C h i n e s e capitalist cadre,

the seams. As de Dios and Esfahani argue, this moves the system closer

these fe atures , the authors argue, have led to the adoption of informa­

to a "joint monopolist" regime in which the executive has strong incen ­

tion- revealing mechanisms and the emergence of strong cross- regional

tives to keep rent - s e eking and co rrup t i o n fro m sucking up i nvestment

c o m p e t i t i o n as i n fo rmal means to e n fo r c e inve s t m e n t agre e m e n t s in

and growt h . Unfo rtunate ly, as these co authors s o vividly i l l u s trate in

China, where formal legal institutions are weak, and, as a by- product, to

their analy s i s of the P h i l i p p i n e s ' p o s twar exp e r i e n c e , it also creates a

i n direct means o f co ntaining corruption.5

s e r i o u s credible c o mmitment p r o b l e m : a s t r o n g executive b ranch i n ­

In h i s chapter o n Korea, Chang takes a slightly different route but

c r e a s e s t h e r i s k t o i n ve s t o r s of h a v i n g a g r e e m e n t s r e a c h e d u n d e r a

e s s e n tially arrives at a s i m i l a r c o n c l u s i o n : c o rru p t i o n i s an e s s e n tial

p articular regime "reconstructed" if key p o liticians of that regime fail to

element of an "e c o n o mic" governance sys tem that has b e e n very suc­

win re election or, as in the case of the Philip pines, are restricted by law

c e s s ful at s t i mulating p r ivate investment. The Korean government, h e

to term limits.6 The recent political events in the Philippines-the so- called

argu e s , c o u l d and did set up a system of highly interventionist policies

P e o p l e Power Revolution 2-wh ich has led to the unseating of

that ( 1) made domestic investment much more attractive than consump ­

elected president well within the constitutional term of six years , highlights

t i o n , (2 ) created m o n o p oly rents fo r large domestic firms (chaebols) in

the de D i o s -Esfahani dilemma. The President, Joseph Estrada, exerc ised

4

5

a

duly

Introduction

Introduction

the full p owers vested in him by the Constitution to influence decisions

t i o n , which is a fo rm of t e c h n o l ogical c h a n g e , altered the M al ays i a n

in favor of individuals and groups who could fork out large sums of money

e c o n o m i c l a n d s c a p e s o drastically t h a t instituti o n s c o u l d not p o ssibly

in bribes. While this practice may not have been unique to him, the manner

adapt to the changes quickly enough. The resulting institutional gap, he

in which h e had d o n e s o created c o n s i derable u n c e rtainty among the

conclude s , has b rought fo rth the economic crisis.

business community and eventually shut off p rivate investment. Presiden­

Malaysia's p o stwar history and its experience with the current crisis

tial influence was exercised randomly, with little rhyme or reason, inevitably

exemplify the difficulty of undergoing fundamental institutional change .

affecting existing or proposed co ntractual arrangements; o nly the avail­

Among the six countries in this volume, M alaysia is unique in the sense

ability and size o f p ayoffs seem to have matte r e d . Even the s u p p o s e d

that it has ranked c o n s i d e rably high o n the "rule o f law" scale as re ­

built-in discipline of a "joint monopolist" came to be violated.7 A s Fabella

flected in various international surveys of businessmen (or alternatively,

aptly put it, the president had moved beyond the "Twilight Zone" o f cor­

c o n s i d e r a b ly l o w o n t h e c o rrup t i o n r a n k i n g s ) . A n d y e t , c r i t i c s h ave

ruption and rent - s e eking, i . e . , what could b e tolerated by the economy,

blamed ren t - s e eking and c o rrupt practices fo r the country's failure t o

thereby creating uncertainty and strong negative reactions from the busi­

thwart the A s i a n c o ntagi o n . Jomo's c h a p t e r o ffers a stinging rebuke o f

ness community and eventually from many segments of civil society.s The

such criticisms. Like t h e other authors, he makes a strong case for rent­

dilemma of balancing the need for a strong executive and the potential for

s e e k i n g and c o rr u p t i o n a s b e i n g p a r t a n d p a r c e l of " e c o n o m i c"

gridlock is indeed a very real dilemma for nascent democracies, especially

governance and implicit contract enforcement in M alaysia. He emphati­

those in transition from an authoritarian state.

cally argu e s , h owever, that fin a n c i al l i b e ralizat i o n created a d e e p and

Implicit in de Dios's and Esfahani's argument is the assumption that

w i d e i n s t i t u t i o n al gap t h a t u l t i m a t e l y t r a n s l a t e d i n t o a r g u a b l y t h e

b o th the jud iciary and p olitical p arties are weak. As the experience of

country's m o s t serious p o s twar economic crisis. Financial liberalizatio n

many former communist countries indicates, this is likely to b e the case

required changes in regulat o ry and legal institutions; and these changes

fo r c o u n t r i e s u n d e r g o i n g the t r a n s i t i o n t o d e m o c r a t i c rul e . 9 P o l itical

directly challenged the institutional arrangements that underpinned the

p arties are m o r e likely t o represent t e m p o rary c o al i t i o n s rathe r than

country's economic governance system, i . e . , arrangements that had rent­

ideologically grounded o rganizatio n s and the judiciary to b e hampered

seeking and corruption at the very core of the country's "shared gro\\