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Governance and Anti-corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward

Discussion paper by Khan, Mushtaq H., 2006

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International institutions and in particular the World Bank and the IMF are rightly giving a great deal of attention to issues of governance in developing countries, and particularly corruption. This paper identifies a number of different structural drivers of corruption that operate because of the poor fiscal capacities and structurally weak property rights of developing countries. These imply that aggregate corruption is likely to be high in all developing countries, but successful countries have institutions and governance capabilities that enable them to “manage” the structural drivers in ways that allow economic development and in turn create the conditions for a sustained improvement in good governance. In contrast, other developing countries lack these institutions and capabilities and suffer from poor economic prospects and political instability to varying extents.

G-24 Discussion Paper Series


Governance and Anti-Corruption


Reforms in Developing Countries:


Policies, Evidence and Ways Forward


Mushtaq H. Khan


No. 42, November 2006


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iiiGovernance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


PREFACE


The G-24 Discussion Paper Series is a collection of research papers prepared
under the UNCTAD Project of Technical Support to the Intergovernmental Group of
Twenty-Four on International Monetary Affairs and Development (G-24). The G-24
was established in 1971 with a view to increasing the analytical capacity and the
negotiating strength of the developing countries in discussions and negotiations in the
international financial institutions. The G-24 is the only formal developing-country
grouping within the IMF and the World Bank. Its meetings are open to all developing
countries.


The G-24 Project, which is administered by UNCTAD’s Division on Globalization
and Development Strategies, aims at enhancing the understanding of policy makers in
developing countries of the complex issues in the international monetary and financial
system, and at raising awareness outside developing countries of the need to introduce
a development dimension into the discussion of international financial and institutional
reform.


The research papers are discussed among experts and policy makers at the meetings
of the G-24 Technical Group, and provide inputs to the meetings of the G-24 Ministers
and Deputies in their preparations for negotiations and discussions in the framework of
the IMF’s International Monetary and Financial Committee (formerly Interim Committee)
and the Joint IMF/IBRD Development Committee, as well as in other forums.


The Project of Technical Support to the G-24 receives generous financial support
from the International Development Research Centre of Canada and contributions from
the countries participating in the meetings of the G-24.






GOVERNANCE AND ANTI-CORRUPTION
REFORMS IN DEVELOPING COUNTRIES:


POLICIES, EVIDENCE AND WAYS FORWARD


Mushtaq H. Khan


Professor of Economics
School of Oriental and African Studies


University of London


G-24 Discussion Paper No. 42


November 2006






viiGovernance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


Abstract


International institutions and in particular the World Bank and the IMF are rightly giving a
great deal of attention to issues of governance in developing countries, and particularly
corruption. While they are right to believe that governance matters, governance in the most
successful developing countries has often been starkly at variance with the good governance
model. Even the most successful developing countries have suffered from significant
corruption and other governance failures during the early stages of their development. This
should not be interpreted to mean that corruption and the goals of good governance are not
important. Pressure to reduce corruption and move towards good governance is both
necessary and desirable but these ends cannot be achieved unless attention is also given to
other governance capacities required for accelerating and sustaining growth. The very
desirable goals of good governance may be neither necessary nor sufficient for accelerating
and sustaining development. We identify a number of different structural drivers of corruption
that operate because of the poor fiscal capacities and structurally weak property rights of
developing countries. These imply that aggregate corruption is likely to be high in all
developing countries, but successful countries have institutions and governance capabilities
that enable them to “manage” the structural drivers in ways that allow economic development
and in turn create the conditions for a sustained improvement in good governance. In contrast,
other developing countries lack these institutions and capabilities and suffer from poor
economic prospects and political instability to varying extents. The challenge for developing
countries is to learn the right lessons from the international experience and identify reform
agendas appropriate and feasible for their own circumstances. Even the most successful
anti-corruption strategies are unlikely to result in dramatic across-the-board improvements
in most developing countries. But if they are properly designed to attack the most damaging
effects of particular types of corruption, they may still be very successful in accelerating
economic development and improving the conditions of political viability. The current
governance and anti-corruption agendas supported by international agencies do not achieve
this. They do not identify the structural drivers of corruption, and they do not identify feasible
responses to these drivers that are likely to improve development prospects in particular
countries. More worryingly, by setting broad anti-corruption and good governance goals
they may be doing damage by setting unachievable targets for developing countries and
diverting attention from critical governance reforms.






ixGovernance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


Table of contents


Page


Preface ............................................................................................................................................ iii


Abstract ........................................................................................................................................... vii


1. The new agenda of good governance and anti-corruption ..................................................... 3


2. The empirical evidence ............................................................................................................... 5


3. Conventional anti-corruption policies: the “greed plus discretion” analysis ..................... 12


4. Structural drivers of corruption in developing countries ..................................................... 14


5. Conclusions ................................................................................................................................ 21


References ........................................................................................................................................... 22


List of tables


1 Interdependent good governance reform agenda ......................................................................... 4
2 Governance and growth, 1980–1990 ............................................................................................ 7
3 Governance and growth, 1990–2003 ............................................................................................ 8
4 Corruption and growth, 1980–1990 .............................................................................................. 9
5 Corruption and growth, 1990–2003 ............................................................................................ 10


List of figures


1 Analytical foundations of good governance ................................................................................. 4
2 Governance and growth 1980–1990 ............................................................................................. 7
3 Governance and growth 1990–2003 ............................................................................................. 8
4 Corruption and growth 1980–1990 ............................................................................................... 9
5 Corruption and growth 1990–2003 ............................................................................................. 10
6 Governance reforms critical for growth versus good governance reforms ................................ 11
7 Drivers of political corruption in developing countries ............................................................. 16
8 Drivers of non-market asset transfers in developing economies ................................................ 18
9 Critical drivers of predation and extortion ................................................................................. 19






International institutions and in particular the
World Bank and the IMF are rightly giving a great
deal of attention to issues of governance and institu-
tions in developing countries, and they are particu-
larly concerned with corruption. There is strong
evidence that governance and institutions matter in
accelerating development and in reducing poverty
in developing countries. However, the evidence
strongly suggests that there is no common set of in-
stitutions that all successful developing countries
have shared. More worrying is the observation that
governance and institutions in the most successful
developing countries have often been starkly at vari-
ance with the good governance model that interna-
tional agencies are committed to. Even the most
successful developing countries have suffered from
significant corruption and other governance failures
during the early stages of their development. How-
ever, they did have significant governance capaci-
ties that allowed states to ensure that the conditions
for rapid growth and sustained political legitimacy
of the state were maintained. A sustained pressure
to reduce corruption and improve governance is both


necessary and desirable but these ends cannot be
achieved unless attention is also given to the gov-
ernance capacities required for accelerating and sus-
taining growth. The very desirable goals of good
governance may be neither necessary nor sufficient
for accelerating and sustaining development. Nev-
ertheless, some types of anti-corruption and govern-
ance reforms are likely to be part of a sustainable
development strategy in most countries. The chal-
lenge for developing countries trying to devise in-
stitutional reform and anti-corruption strategies is
to learn the right lessons from the international
experience and create feasible governance reform
agendas appropriate and feasible for their own cir-
cumstances. The current governance and anti-cor-
ruption agendas do not achieve this and may even
be doing damage by setting unachievable targets for
developing countries and diverting attention from
critical governance reforms.


Section 1 discusses the analysis behind the new
governance and anti-corruption agendas that have
been widely adopted by international agencies. This


GOVERNANCE AND ANTI-CORRUPTION
REFORMS IN DEVELOPING COUNTRIES:


POLICIES, EVIDENCE AND WAYS FORWARD*


Mushtaq H. Khan


* This work was carried out under the UNCTAD Project of Technical Assistance to the Intergovernmental Group of Twenty-
Four on International Monetary Affairs and Development with the aid of a grant from the International Development Research
Centre of Canada.




2 G-24 Discussion Paper Series, No. 42


agenda is based on developments in economics that
identify the importance of reducing transaction costs.
However, this policy agenda is based on a partial
reading of theory and evidence. Section 2 discusses
the empirical evidence on which the agenda of good
governance and anti-corruption reforms is based. It
shows that despite serious weaknesses in this data,
in particular its foundation in subjective indices, the
data is far less supportive of the dominant policy
agenda than appears at first sight. By separating con-
verging and diverging developing countries, we show
that the differences in governance and corruption
between these groups are negligible. We conclude
that while there are significant governance differ-
ences between these two sets of developing coun-
tries, these are not captured in the conventional
governance indicators. A range of case studies have
identified some of the critical governance capacity
differences between these countries, and policy
should focus on adapting these lessons to the initial
conditions of reforming countries.


Section 3 discusses the specific analytical ar-
guments behind the anti-corruption policies followed
in many developing countries and supported by in-
ternational agencies. Mainstream anti-corruption
policy is based on the assumption that corruption is
caused primarily by the greed and discretionary pow-
ers of public officials, an analysis that we describe
as the “greed plus discretion” theory of corruption.
The major policy planks of conventional anti-cor-
ruption policy (liberalization, privatization, increas-
ing salaries for public officials, rule of law reforms,
greater transparency and democratization), all fol-
low from this. However, here again, econometric and
case study evidence suggests that these policies have
not achieved very much in reducing corruption.


Section 4 identifies four other types of corrup-
tion in developing countries that point to a different
set of drivers that are not addressed by conventional
anti-corruption policies. The first is the corruption
and rent seeking that is associated with necessary
state interventions that cannot be addressed through
privatization or liberalization. Here the reform pri-
ority should be to strengthen state capacities to carry
out these functions, and at the same time to legalize
and regulate the associated rent seeking.


The second is the important area of political
corruption associated with attempts of many devel-
oping country states to maintain political stability in
a context of severe fiscal scarcity. This driver of


corruption cannot be addressed using any of the con-
ventional programmes, and indeed explains why
political corruption is ubiquitous in developing coun-
tries. The reform priority here should be to identify
the organization of patron-client politics in each
country and to limit the most damaging effects. The
long-term solution is to increase fiscal space to the
point where political stabilization can be achieved
through transparent fiscal transfers to all deserving
constituencies.


The third driver of corruption is the structural
weakness of property rights in countries where most
assets are still unproductive and cannot pay for their
protection. This structural problem is strongly sup-
ported by New Institutional Economics but has not
found its way into the policy discussions around
governance and anti-corruption reforms. We argue
that the importance of this driver also explains why
weakly protected property rights and the associated
corruption appear to be ubiquitous in developing
countries, even in high-growth ones. However, high-
growth countries have strategies to ensure that critical
productive sectors enjoy the stability of expectations
that allows high-value investment and growth to
continue and this should inform feasible reform ef-
forts in other developing countries.


Finally, predatory corruption and extortion are
potentially the most serious problem for some de-
veloping countries. While the state collapse that
allows predation to become dominant has many
causes, its critical characteristic is the collapse of
the enforcement capacities of the central state. Here,
anti-corruption strategies have to recognize the im-
portance of strengthening the enforcement capacities
of states at risk of descending into predation.


Our analysis of the drivers of corruption can
help to explain why all developing countries suffer
from relatively high levels of corruption in aggre-
gate. But while all corruption is damaging to some
extent, some types of corruption are much more dam-
aging than others. The evidence strongly supports
such an interpretation. While all developing coun-
tries suffer from corruption at early stages of
development, high-growth countries suffered less
from the most damaging types and they also had
governance strategies that allowed them to avoid the
most damaging effects of other types of corruption.


Section 5 concludes. The policy implication of
our analysis is that the focus on corruption in gen-




3Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


eral (and a long list of good governance reforms) in
developing countries diverts attention away from
feasible policies that can make a difference to economic
performance. If there are many different types of cor-
ruption in developing countries, and if it not possi-
ble to attack all of them simultaneously, it is critical
to acquire the governance capabilities to identify and
limit the most damaging types of corruption. A frame-
work for distinguishing between types of corruption
is critical for setting national institutional reform
priorities and successful anti-corruption strategies.


All these arguments point to the importance of
having institutional reform and anti-corruption strat-
egies tailored to the particular circumstances of coun-
tries. Without that, anti-corruption strategies and
institutional reform agendas can have a damaging
effect by setting developing countries unattainable
targets and creating demoralization and reform fatigue.


1. The new agenda of good governance
and anti-corruption


Corruption takes place when public officials
break the law in pursuit of their private interest. The
most odious forms of corruption include bribery and
extortion, but it can also include other forms such as
the allocation of public resources to favoured cli-
ents for political benefit. Clearly, corruption is a cost
to developing countries in many different ways, in-
cluding the subversion of development plans, the
diversion of resources that may have been invested
productively, as well as disrupting the transparent
and normal operation of markets and thereby creat-
ing uncertainty for investors. However, in recent
years, there has been a much more concerted focus
on corruption coming from international agencies
based on an integrated analysis of the role of gov-
ernance in improving the prospects of development
in developing countries.


The new analysis of corruption forms part of
an integrated analysis of good governance. The core
arguments come from New Institutional Economics
that has defined efficient markets as markets with
low transaction costs. Transaction costs are the costs
of conducting transactions, and include in particular
the costs of negotiating and enforcing contracts. If
these costs are very high, markets are inefficient,
and critical transactions like long-term investments


are unlikely to happen. It turns out that the good
governance conditions that many people in devel-
oping countries desire as goals of development can
theoretically be presented as preconditions or means
for ensuring development, because they are institu-
tional and political conditions for ensuring low trans-
action costs in market economies.


The economic analysis supporting the good
governance reforms promoted by international agen-
cies is summarized in figure 1. Poor performance in
economic development is explained (arrow 1 in fig-
ure 1) by inefficient, high transaction cost markets
(North, 1990; North, 1995). The persistence of ineffi-
cient markets (arrow 2 in figure 1) is in turn explained
by welfare-reducing interventions of governments, but
most importantly, by insecure property rights that are
expensive to protect and transact with. The persist-
ence of unstable property rights and welfare-reducing
interventions in developing countries is then ex-
plained (arrow 3 in figure 1) by rent seeking and
corruption through which small numbers of rent
seekers buy themselves the ability to capture prop-
erty or induce interventions that help them at the
expense of broader society (Krueger, 1974; Mauro,
1995; Bardhan, 1997; Mauro, 1997a; Mauro, 1997b;
Kaufmann et al., 1999). But why are these relatively
few beneficiaries of corruption and rent seeking able
to continue their activities even though the vast ma-
jority of society suffers? The answer (arrow 4 in
figure 1) is that the majority is poorly organized and
there is an absence or weakness of democratic ac-
countability that allows the minority to effectively
exploit the majority (Clague et al., 1997; Olson,
2000). Poverty and underdevelopment in turn limit
the organizational capacity of the majority (arrow 5
in figure 1), thereby locking the system into sus-
tained poverty and underdevelopment.


It is from this theoretical perspective that the
good governance analysis proposes a set of parallel
policy priorities that have to be simultaneously fol-
lowed to break out of the poverty trap described in
figure 1. These interrelated set of policies combine
economic reform with institutional and political re-
form and have come to be known as the good
governance reform agenda. Some of the critical com-
ponents of this package are summarized in table 1.
Its novel feature is that it explicitly goes beyond the
traditional focus of economic reform on market com-
petitiveness to include a wide range of political and
institutional reforms. Thus, instead of simply focus-
ing on arrow 1 in figure 1, that is on economic




4 G-24 Discussion Paper Series, No. 42


reforms such as liberalization, the good governance
agenda in table 1 argues that it is necessary to si-
multaneously address institutional reforms that
improve the stability of property rights and the rule
of law (arrow 2 in figure 1), anti-corruption reforms
and attacks on rent seeking more widely (arrow 3)


and reforms that seek to improve the accountability
of governments (arrow 4). Clearly, anti-corruption
reforms play a significant role in the new reform
agenda, and this is why anti-corruption reforms have
an importance well beyond the importance of cor-
ruption seen as a problem in isolation.


Contested/Weak
Property Rights and
Welfare-Reducing


Interventions


High Transaction
Cost Markets


Rent-Seeking and
Corruption


Unaccountable
Government










Economic
Stagnation


Figure 1


ANALYTICAL FOUNDATIONS OF GOOD GOVERNANCE


Table 1


INTERDEPENDENT GOOD GOVERNANCE REFORM AGENDA


Policies to improve accountability Policies to counter corruption Policies to stabilize property rights
of government and rent seeking across the board


PRSP, PGBS (in some countries), Anti-corruption policies, Policies to improve rule of law,
accountability reforms, liberalization, WTO restrictions reduce expropriation risk,
decentralization on subsidies, IMF fiscal strengthen judiciaries


requirements




5Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


2. The empirical evidence


The empirical evidence shows that while there
is at best a weak relationship between the govern-
ance conditions identified in the good governance
agenda and improved economic growth; there are
other more important governance conditions neces-
sary for accelerating and sustaining economic growth
that are not identified at all in the good governance
approach. The identification of the most important
conditions for accelerating and sustaining economic
development is clearly of paramount importance for
developing countries. While the good governance
conditions are for the most part desirable on their
own terms, the empirical question is whether the good
governance agenda identifies the necessary conditions
and critical priorities for reform. Our examination of
the empirical evidence suggests that it does not. Later
we will argue that the good governance conditions
and in particular a drastic reduction of corruption
may not even be achievable in most developing coun-
tries, regardless of their potential benefit.


An immediate problem for any comparative
empirical work is that governance quality and par-
ticularly corruption cannot be directly measured and
so proxy indicators have to be constructed using
subjective judgements and opinions. These indices
have well-known problems of bias and subjectivity.
In particular, small differences in scores of coun-
tries, either over time or compared to other similar
countries are not trustworthy (Khan, 2006a; Søreide,
2006). Nevertheless, even if we use these indicators
(which are widely used in policy advocacy) a care-
ful examination reveals that some of the strong
results in support of the good governance agenda
derived using these indicators cannot be justified.
This is a particularly important conclusion given the
large number of econometric studies that appear to
show some relationship between governance indi-
cators including corruption, the rule of law, and other
good governance characteristics and economic
performance (Knack and Keefer, 1995; Mauro, 1995;
Knack and Keefer, 1997; Mauro, 1997a; Johnson et
al., 1998; Hall and Jones, 1999; Kaufmann et al., 1999).


These relationships are strongest for relation-
ships between governance quality and per capita in-
come, in effect showing that richer countries have
better governance, lower corruption and so on. But
the direction of causality is difficult to establish in
such studies because it could be that higher per capita


incomes and levels of development in general al-
lowed the emergence of better governance condi-
tions. For corruption and other governance indicators
to be accepted as policy targets, we need to estab-
lish a relationship between these governance indi-
cators and economic growth rates. To begin with,
the relationship with growth rates is much weaker,
and often disappears with the inclusion of other vari-
ables such as the investment rate (Mo, 2001). But
this is not the only problem.


While there is no reason to deny that if sustain-
able improvements in corruption and other govern-
ance variables could be achieved, overall economic
performance, even in terms of growth rates would
improve to some extent, the evidence in support of
this is very weak and calls for much greater caution
in the design of reform priorities. The main problem
in empirical studies is that we have to be careful to
compare like with like, and it is very difficult to iden-
tify two countries that are different only in terms of
a governance indicator. In particular, countries are
at different levels of development, and to make sense
of their growth performance, we need to at least split
the countries into an advanced (high income) coun-
try group and the rest, which we can loosely describe
as the developing country group including transi-
tion economies.


Most of the relationships between good gov-
ernance characteristics and economic performance
appear to emerge when we pool all countries to-
gether. But more interesting insights emerge when
we split countries into advanced and others, and then
split the latter group into a group of converging and
a group of diverging countries. Converging coun-
tries are developing countries that are converging to
advanced country living standards as a result of
achieving growth rates higher than the advanced
country average. Diverging countries are those that
are falling further behind as a result of growth rates
that are lower than the advanced country average.
Grouping countries in this way reveals some strik-
ing features in the data that casts doubt on some of
the core aspects of the conventional wisdom. We
conclude that while there are very likely to be im-
portant governance differences between converging
and diverging developing countries, these differences
are not captured in the indices of good governance
on which conventional policy focuses.


Our figures 2 to 5 and the accompanying ta-
bles 2 to 5 use governance and corruption indices




6 G-24 Discussion Paper Series, No. 42


from the IRIS centre at the University of Maryland,
compiled by Knack and his colleagues (IRIS-3,
2000). While all indices of governance suffer from
significant problems of subjectivity, these indices are
widely used and suffice to demonstrate the main fea-
tures of the problem. (Similar results are obtained if
we use the World Bank’s indices compiled by
Kaufmann et al. (2005) except that the latter indices
are only available from 1996). The IRIS governance
index is available from 1984 and is an amalgam of
five separate indices for “corruption in government”,
“rule of law”, “bureaucratic quality”, “repudiation
of government contracts”, and “expropriation risk”.
It ranges from 0 (the poorest score) to 50 (the highest
score). We also use the corruption index separately,
which ranges from 0 (the poorest score) to 6 (the
highest score).


Looking at the two decades of the 1980s and
1990s, we plot the governance indicator for the be-
ginning of a period against the per capita growth
rate achieved in that country in the subsequent dec-
ade. As the earliest governance indices are only
available from 1984, the exercise for the 1980s is
less accurate than for the 1990s. This is because we
expect higher per capita incomes to lead to better
governance over time, and if a country has been
growing rapidly for a while, its higher per capita
incomes will dispose it to better governance charac-
teristics even if these did not exist at the beginning
of the period. Thus, if our governance data comes
for a year in the middle or towards the end of the
growth period, we could wrongly conclude in some
cases that better governance had caused growth
even though the causality was in the opposite direc-
tion.


As we would expect, our data plots show that
advanced countries score better on all governance
indicators compared to developing countries, but to
a large extent this could be because there is a re-
verse causality operating from higher levels of per
capita incomes to better scores on these specific
governance indicators. The really interesting obser-
vations are for comparisons of converging (high
growth) and diverging (low growth) developing
countries. The data show that the difference in gov-
ernance indicators for these two groups is negligible
both in terms of general governance as well as for
each specific governance indicator. Of the different
components of the overall governance indicator, we
have also shown the results for the corruption indi-
cator.


Figure 2 and table 2 show that for the 1980s,
the pooled data for all countries shows a weak posi-
tive relationship between good governance quality
and economic growth. However, a closer look shows
that the overall governance indicator was only very
marginally better for converging developing coun-
tries compared to diverging developing countries.
More important, both were significantly worse than
advanced countries. The very small difference be-
tween converging and diverging developing countries
is particularly noteworthy given that the governance
indicator for the 1980s is only available for 1984,
almost halfway through the decade. But in any case,
the very large difference in growth rates between
converging and diverging developing countries is
associated with a very small difference in govern-
ance quality.


The comparison between converging and di-
verging developing countries becomes even starker
when we look at the data for the 1990s in figure 3
and table 3. Once again, there is no significant dif-
ference between converging and diverging develop-
ing countries, but during this decade, the median
converging developing country had a marginally
poorer governance index compared to the median
diverging developing country. We should not read
too much into this reversal except to say that this
confirms even more definitively that the two sets of
developing countries did not differ significantly in
terms of their performance in terms of good govern-
ance.


These results just reported for the overall gov-
ernance indicator are replicated when we look at
indices for each of the component governance char-
acteristics out of which the overall governance
indicator is constructed. The corruption index is one
of the key constituent indices of most governance
indicators, and we now turn to data on the corrup-
tion index on its own. In the 1980s, converging
developing countries scored slightly better on the
1984 corruption index compared to diverging de-
veloping countries, but both scored significantly
worse than advanced countries (figure 4 and table 4).
This simply replicates the result for the overall gov-
ernance indicator.


However, just as with the overall governance
indicator, in the 1990s (figure 5 and table 5) the slight
difference between converging and diverging devel-
oping countries disappears completely. The median
corruption index in converging and diverging de-




7Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


Table 2


GOVERNANCE AND GROWTH, 1980–1990


Diverging Converging
Advanced developing developing
countries countries countries


Number of countries 21 52 12


Median Property Rights Index, 1984 45.1 22.5 27.8


Observed range of Property Rights Index 25.1–49.6 9.4–39.2 16.4–37.0


Median per capita GDP growth rate, 1980–1990 2.2 -1.0 3.5


Source: IRIS-3 (2000), World Bank (2005).
Note: The IRIS Property Rights Index can range from a low of 0 for the worst governance conditions to a high of 50 for the best


conditions.


Figure 2


GOVERNANCE AND GROWTH 1980–1990


Source: IRIS-3 (2000), World Bank (2005).


veloping countries was exactly the same in the 1990s,
though both scored significantly worse on corrup-
tion compared to advanced countries. The weak
positive relationship between the corruption and
other governance indicators and economic growth
in the pooled data is therefore misleading. A similar


analysis for other governance indicators is available
in (Khan, 2006c).


This does not mean that there are no signifi-
cant governance differences between converging and
diverging developing countries. However, it does


-7


-5


-3


-1


1


3


5


7


9


11


0 10 20 30 40 50


IRIS Property Rights Index 1984 (ranges from 0 to 50)


G
ro


w
th


R
at


e
of


P
er


C
ap


ita
G


D
P


1
98


0–
90


Advanced Countries Converging Developing Countries Diverging Developing Countries




8 G-24 Discussion Paper Series, No. 42


Table 3


GOVERNANCE AND GROWTH, 1990–2003


Diverging Converging
Advanced developing developing
countries countries countries


Number of countries 24 53 35


Median Property Rights Index, 1990 47.0 25.0 23.7


Observed range of Property Rights Index 32.3–50.0 10.0–38.3 9.5–40.0


Median per capita GDP growth rate, 1990–2003 2.1 0.4 3.0


Source: IRIS-3 (2000), World Bank (2005).
Note: The IRIS Property Rights Index can range from a low of 0 for the worst governance conditions to a high of 50 for the best


conditions.


mean that the important differences in their govern-
ance characteristics are not identified by the good
governance analytical framework.


This proposition is summarized in figure 6.
Converging and diverging developing countries


(groups 1 and 2 in figure 6) do not differ signifi-
cantly if at all in terms of their average governance
characteristics, but they differ very significantly in
terms of their economic growth performance. The
lack of any significant difference between groups 1
and 2 is even more remarkable if we remember that


Figure 3


GOVERNANCE AND GROWTH 1990–2003


Source: IRIS-3 (2000), World Bank (2005).


-8


-6


-4


-2


0


2


4


6


8


10


0 10 20 30 40 50


IRIS Property Rights Index 1990 (ranges from 0 to 50)


G
ro


w
th


R
at


e
of


P
er


C
ap


ita
G


D
P


1
99


0–
20


03


Advanced Countries Converging Developing Countries Diverging Developing Countries




9Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


Table 4


CORRUPTION AND GROWTH, 1980–1990


Diverging Converging
Advanced developing developing
countries countries countries


Number of countries 21 52 12


Median Corruption Index, 1984 5.4 2.6 3.0


Observed range of Corruption Index 3–6 0–6 1–5


Median per capita GDP growth rate, 1980–1990 2.2 -1.0 3.5


Source: IRIS-3 (2000), World Bank (2005).
Note: The IRIS Corruption Index can range from a low of 0 for the worst corruption to a high of 6 for the lowest corruption.


countries in group 2 are considerably richer than
those in group 1 because they have typically been
growing for some time.


The challenge for diverging developing coun-
tries is how to improve their growth performance,


and for converging countries, to sustain and improve
on what they have already achieved. The good gov-
ernance agenda suggests that diverging countries
(group 1) could aspire to become group 3 countries
by implementing good governance reforms and
moving rightwards and upwards in the diagram.


Figure 4


CORRUPTION AND GROWTH 1980–1990


Source: IRIS-3 (2000), World Bank (2005).


-7


-5


-3


-1


1


3


5


7


9


11


0 1 2 3 4 5 6 7


IRIS Corruption Index 1984 (ranges from 0 to 6)


G
ro


w
th


R
at


e
of


P
er


C
ap


ita
G


D
P


1
98


0–
90


Advanced Countries Converging Developing Countries Diverging Developing Countries




10 G-24 Discussion Paper Series, No. 42


Table 5


CORRUPTION AND GROWTH, 1990–2003


Diverging Converging
Advanced developing developing
countries countries countries


Number of countries 24 53 35


Median Corruption Index, 1990 5 3 3


Observed range of Corruption Index 2–6 0–5 0–5


Median per capita GDP growth rate, 1990–2003 2.1 0.4 3.0


Source: IRIS-3 (2000), World Bank (2005).
Note: The IRIS Corruption Index can range from a low of 0 for the worst corruption to a high of 6 for the lowest corruption.


However, this assertion is based on the type of theory
and evidence discussed above, and not on any his-
torical observation of any developing country that
first improved the governance characteristics de-
scribed as good governance and then increased its
growth rate even to advanced country levels.


Rather, the historical evidence tells us very
strongly that the challenge for diverging countries
is to discover the policy and governance changes
that allowed countries to graduate from group 1 to
group 2 and stay there for several decades. Even for
group 2 countries, the challenge is often to under-


Figure 5


CORRUPTION AND GROWTH 1990–2003


Source: IRIS-3 (2000), World Bank (2005).


-8


-6


-4


-2


0


2


4


6


8


10


-1 0 1 2 3 4 5 6 7


IRIS Corruption Index 1990 (ranges from 0 to 6)


G
ro


w
th


R
at


e
of


P
er


C
ap


ita
G


D
P


1
99


0–
20


03


Advanced Countries Converging Developing Countries Diverging Developing Countries




11Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


stand better what they themselves have achieved
often through serendipity or good luck so that the
good performance can be sustained over time. It is
undoubtedly true that once growth has set in, it is
desirable to carry out second phase good govern-
ance reforms that allow the country to graduate from
group 2 to group 3. This transition is by no means
automatic and it may even be that some of these re-
forms are necessary to sustain growth in countries
that are becoming mature. However, there is little
evidence that these second stage reforms are fully
implementable in poor countries, and no evidence
that these reforms are preconditions for growth in
poorly performing countries.


The governance capacities that have sparked
off and sustained growth in group 2 have been the
subject of extensive research by development econo-
mists specializing in this field. This research has
identified a number of specific governance capaci-


ties that distinguish converging developing countries.
These include capacities for protecting the assets and
resources of critical productive sectors, directing
assets and resources to these sectors, assisting these
sectors to acquire more advanced technologies, regu-
lating and disciplining the market so that there are
credible compulsions for productivity growth in pro-
ductive sectors, and maintaining adequate social
stability and legitimacy through redistributive strat-
egies. Some of this literature is reviewed in Khan
(2004).


The problem is that there was no single set of
institutions that achieved these ends (and that too to
varying degrees) in different countries. The govern-
ment-business partnership that achieved (some or all)
of these goals in the Republic of Korea in the sixties
was very different from the strategy followed by Ma-
laysia in the 1970s, and very different again from
that in China’s export-oriented industries or in In-


Figure 6


GOVERNANCE REFORMS CRITICAL FOR GROWTH VERSUS GOOD GOVERNANCE REFORMS


Source: Khan (2004).


G
ro


w
th


R
at


es


Governance Characteristics
(Degree of Democracy,
Extent of Corruption,


Stability of Property Rights)


1. Diverging Developing Countries


2. Converging Developing Countries


3. Advanced Capitalist
Countries



Reg


ressi
on Lin


e


Reforms suggested
by Good Governance


and related frameworks
(but very little historical evidence of this trajectory )


Reforms that transform Failing States
into Developmental States


Reforms that improve


governance in


successful
transformation


economies




12 G-24 Discussion Paper Series, No. 42


dia’s software sector. These differences in the inter-
national arrangements that sustained growth can be
traced to differences in initial institutional, political
and economic conditions, since new institutions do
not just have to address critical economic require-
ments; they also have to be implementable given the
political settlement and the already existing institu-
tional capacities of the state (Amsden, 1989; Wade,
1990; Khan, 2000a; Khan and Jomo, 2000; Rodrik
et al., 2002; Rodrik, 2003; Khan, 2004; Rodrik and
Subramanian, 2004).


In its much earlier study of the role of govern-
ance in East Asian development, the World Bank
(1993) recognized the critical role of the state in the
rapid developers in assisting technology acquisition
and upgrading, but concluded that because these
governance capacities were missing in other devel-
oping countries, it would be very risky for the
average developing country to follow these strate-
gies. In one sense this conclusion was correct because
without appropriate governance capacities, the at-
tempt by states to accelerate and sustain development
would only result in mistakes with the added costs
of rent seeking. However, this conclusion was actu-
ally very misleading because it implicitly asserted
without any evidence that there was another route
from group 1 to group 3 in figure 6 that was based
on states acquiring good governance capacities. Our
argument is that there is no historical evidence for
this.


In effect, the World Bank was asking countries
with very poor governance capacities to achieve new
governance capacities (good governance) that no
poor country had historically achieved and claim-
ing that these governance capacities would then
ensure faster growth, for which again there was no
convincing historical evidence. A more reasonable
response to the evidence would have been to argue
that the best option for developing countries with-
out group 2 governance capacities would be to try
and acquire at least some of the governance capaci-
ties of the rapid developers that would have allowed
them to achieve faster rates of social transformation
than they were achieving.


Since the publication of the World Bank’s East
Asian study (World Bank, 1993), a wealth of new
case studies and evidence has become available
which suggest that this is a critical policy and re-
search agenda. But the objectives of this policy and
research agenda will not be a simple blueprint for


all countries to follow. Rather, it has to focus on iden-
tifying feasible governance reforms tailored for each
country that seeks to achieve improvements in per-
formance by finding local solutions to some of the
problems addressed in more ambitious ways in the
high-growth developers. Examples of these studies
include Rodrik (2003) and Khan and Jomo (2000),
and some of the critical governance capacities in
high-growth developers are summarized in Khan
(2004).


These studies do not suggest that all develop-
ing countries can or should emulate the Republic of
Korea, China or India. Rather, they advocate a much
more nuanced approach that involves looking at the
functions that the state performed in the better per-
formers, the governance capacities that were required
and the institutions that achieved this in each spe-
cific context. To achieve similar functions, even at
lower levels of effectiveness, other countries need
to ask what types of governance capacities and in-
stitutions they could feasibly try to achieve to meet
some of the economic requirements for accelerating
the structural transformation of their economies into
higher growth and higher income economies.


3. Conventional anti-corruption
policies: the “greed plus discretion”
analysis


Having identified corruption and governance
as preconditions for rapid development, the main-
stream approaches to reform carry out a further
simplification that has important policy conse-
quences. They argue that corruption is largely caused
by the greed of public officials who have the discre-
tion to offer citizens benefits or cause damage to their
activities but who are inadequately monitored or face
inadequate punishments for violating laws. If bureau-
crats or politicians have the power to offer selective
benefits or cause selective damage, and if their risk
of detection or risk of punishment is low, they are
likely to engage in corruption to enrich themselves.


There is a large academic and policy literature
that develops aspects of this analysis of the causes
of corruption (Rose-Ackerman, 1978; Klitgaard,
1988; Andvig and Moene, 1990; Shleifer and Vishny,
1993; Mauro, 1995; Bardhan, 1997; Leite and
Weidmann, 1999). Although there are differences in




13Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


detail in the analysis of corruption provided in these
and similar contributions, the similarities between
them on the core drivers allow us to collectively
describe it as the greed plus discretion theory of
corruption.


The standard policy response to corruption is
entirely based on attacking the drivers of corruption
identified in greed plus discretion theories. The well-
known collection of measures to attack corruption
derived from this analysis include:


(i) reducing the discretion of public officials
through liberalization and privatization,


(ii) improving salaries of public officials, thereby
addressing their low living standards in many
cases, but also increasing the opportunity cost
of corruption since they stand to lose their po-
sitions if detected,


(iii) improving the rule of law so that corrupt bu-
reaucrats and politicians can be prosecuted and
punished, and


(iv) encouraging greater transparency of govern-
ment decision-making through deepening
democratization, decentralization and the
creation and encouragement of civil society
watchdogs.


If corruption in developing countries was in-
deed entirely or even largely driven by the factors
identified in the greed plus discretion theory of
corruption, the adoption of these anti-corruption
measures in a wide range of developing countries
would by now have produced significant reductions
in corruption in the countries adopting them. Unfor-
tunately, we know from detailed econometric and
country case studies that many of the core policy
tools identified in the greed plus discretion theories
have limited if any effect on corruption.


(i) For instance, we have a wide range of case stud-
ies from the Indian subcontinent and Eastern
Europe that show that policies of reducing state
discretion through liberalization and privatiza-
tion have done little to reduce corruption in
developing and transition countries. Indeed,
liberalization and privatization have been
accompanied by dramatic increases in corrup-
tion in most cases (Harriss-White and White,
1996).


(ii) Higher salaries and rewards for public officials
are unlikely to work even in theory unless they
are backed up with a credible probability of
officials losing their positions if caught engag-
ing in corruption (Besley and McLaren, 1993).
Since achieving the latter requires very deep
changes in political and legal structures, it is
not surprising that cross-national empirical evi-
dence shows that there is little if any relationship
between pay increases for public officials and
reductions in corruption (Rauch and Evans,
2000; Treisman, 2000).


(iii) While there have been many programmes to
improve the rule of law in developing coun-
tries, there is little evidence that these have had
any effect, and the empirical evidence raises
serious questions about the degree to which
promoting the rule of law in developing coun-
tries has assisted in the reduction of corruption
or the achievement of any other development
objective (Carothers, 2003).


(iv) Strategies of improving transparency and set-
ting up new bodies such as ombudsmen and
commissions are the easiest for external agen-
cies to support, so not surprisingly this is an
area in which a lot of international policy
support has focused. But in a review for the Op-
erations Evaluation Department of the World
Bank, Huther and Shah (2000) agree that many
strategies such as introducing ombudsmen and
raising public awareness of corruption are un-
likely to have any effect on countries where
governance is poorest. Yet they still argue that
reducing the size of the state, increasing citi-
zen participation and (somehow) improving the
rule of law are still the best strategies in coun-
tries with the worst governance record.


On the link between democratization and cor-
ruption, Treisman (2000) in his major cross-country
regression analysis finds no evidence that corrup-
tion is lower in democracies. Democracy did have a
small effect on corruption after many decades but
these long term effects could have other explana-
tions because only successful economic developers
are usually able to sustain long-lasting democracies.


On decentralization, cross-country regression
analysis that includes both advanced and develop-
ing countries (such as Gurgur and Shah, 2000) re-
port that decentralization has a significant effect in




14 G-24 Discussion Paper Series, No. 42


reducing corruption. But this study, for instance, also
points out that when the regressions are carried out for
developing countries alone there is no relationship
between decentralization and corruption-reduction.
The latter result is more significant because includ-
ing both advanced and developing countries in the
same regressions have problems which we have
touched on earlier.


These and other studies that have looked at the
empirical evidence on each of the links crucial for
the greed plus discretion theory of corruption warn
us that the policy focus of conventional anti-corrup-
tion strategies is unlikely to achieve sustained
reductions in corruption, even if the reduction of
corruption were indeed a critical precondition for
development. The empirical evidence should have
alerted policy-makers that there are likely to be other
structural drivers of corruption that are not linked to
the greed and discretion of public officials (though that
may also be one of a number of drivers of corruption).


4. Structural drivers of corruption in
developing countries


The “greed plus discretion” theory of corrup-
tion ignores a number of structural problems that
developing countries face that in turn induce high
levels of corruption of different types. Understand-
ing these structural drivers of corruption can allow
us to adopt more reasonable positions on anti-
corruption policies in developing countries, as well
as allowing us to design anti-corruption policies to
target the most damaging types of corruption. These
critical structural drivers of corruption include the
following:


(a) Corruption associated with necessary state
interventions


A very serious problem with the conventional
anti-corruption agenda is that it presumes that any
discretionary intervention on the part of public in-
stitutions is damaging because such powers are not
only unnecessary for accelerating development, they
create in addition, opportunities for extortion by
public officials. But this assumption is wrong. Ac-
celerating economic development requires the
management of a number of critical interventions,
for instance, to assist domestic producers to catch


up by learning to use new technologies (Khan,
2000b). The evidence of such interventions from all
the successful Asian developing countries is over-
whelming. These interventions are in addition to the
interventions that states need to make on a flexible
basis to sustain welfare. Many of these interventions
are useful and states have to acquire the capacity to
identify, sustain and manage these interventions.
Whenever states have essential functions that are
both socially beneficial and also benefit particular
constituencies, there will necessarily be some rent
seeking that needs to be managed to ensure that so-
cially desirable outcomes can continue to be achieved
(Khan, 2000a; Khan, 2004).


While liberalization is not a solution here, some
of the anti-corruption strategies advocated in the
conventional anti-corruption programme may help
if they could be feasibly implemented. For instance,
improving the rule of law or increasing the opportu-
nity cost for bureaucrats by paying them higher
salaries may help in reducing corruption in areas
where the state has critical functions to perform.
However, we have seen the evidence that shows that
these strategies either do not work or take a long
time to implement. To improve the effectiveness of
states in critical intervention areas, alternative strat-
egies of dealing with damaging rent seeking have to
be followed.


Paradoxically, the answer may lie in the ways
in which advanced countries have dealt with rent
seeking. States in advanced countries play important
roles in managing their economies, and inevitably
this creates incentives for extensive rent seeking. But
much of the rent seeking in advanced countries is
legalized because the underlying interventions and
rents are themselves legal. This allows the rent seek-
ing to be legally regulated (for instance by allowing
industry groups to lobby to promote their interests
within prescribed limits) whereas the rent seeking
in developing countries often takes illegal forms that
are by definition corruption. This is because the
emerging modern sectors in developing countries are
new and interventions to assist them are often infor-
mal and lack wide political support, though this is
not the case in all developing countries, particularly
the more advanced ones.


A critical distinction here has to be made be-
tween the intended outcome of an intervention and
the cost of the rent seeking it induces. If the rent
seeking does not seriously affect the outcome of the




15Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


intervention, the resources used up in the rent seeking
are a social cost, but the net effect of the interven-
tion can still be very positive (Khan, 2000a). Both
the capacity of the state to ensure the effective im-
plementation of the intervention and the institutions
that can limit the rent seeking cost are important,
but the former are most important, because there is
no point in these critical areas to limit the rent seek-
ing cost but fail to achieve the most of the intended
outcomes of intervention. Thus, the priority for de-
veloping countries must be to strengthen the capacity
of the state to assist growth in critical areas such as
technology acquisition or the provision of critical
infrastructure for productive sectors. Nevertheless,
all developing countries can significantly reduce
corruption by identifying these critical state inter-
ventions, legalizing these interventions where they
are not already properly regulated, and this will al-
low the legalization and regulation of the associated
rent seeking as well. At the same time, policy has to
strengthen state capacities and regulatory mechanisms
to manage and regulate both the intervention and the
associated rent seeking.


If we look at the successful high-growth de-
velopers, while all of them continued to suffer from
some corruption even in critical areas, their institu-
tional capacity in these sectors ensured that corrup-
tion did not compromise critical state functions even
if they resulted in some rent seeking or even corrup-
tion. Strengthening these capacities should therefore
be a critical focus of anti-corruption strategies but it
gets very little attention in the reform agenda pre-
sented to developing countries.


(b) Fiscal constraints and the structural drivers
of political corruption


The other drivers of corruption in developing
countries are even more difficult to deal with, but
states need to devise strategies over the medium term
to avert the most damaging effects of these types of
corruption. One of the fundamental problems faced
by states in developing countries is to maintain po-
litical stability in a context of severely limited fiscal
resources. Maintaining political stability in any coun-
try requires, amongst other things, the availability
of sufficient fiscal resources for redistribution to con-
stituencies that have political power or social legiti-
macy but have lost out (even if only in their own
perception) in the allocation of income and resources
through economic processes. Advanced countries tax
between 35 to 50 per cent of their GDP, and a sig-


nificant part of this is redistributed to different con-
stituencies to maintain social cohesion and political
stability. In contrast, the lower share of the modern
sector in the economies of developing countries, to-
gether with institutional weaknesses means that they
can typically tax only around 10 to 25 per cent of
their GDP, and their GDP is of course, much smaller
to begin with. In most developing countries, after
the salaries of public servants have been paid, there
is not much left even for delivering essential serv-
ices or constructing critical infrastructure. In many
developing countries, core developmental spending
is financed by domestic borrowing and external
flows, leaving very little fiscal space for political
stabilization through transparent official redistribu-
tions through the budget though some budgetary re-
distribution does of course take place.


Nevertheless, developing countries do have
powerful constituencies demanding redistribution
and political stability has to be maintained. The lim-
ited redistribution possible through the budget typi-
cally does not achieve this goal. This structural
problem explains the importance of patron-client
networks in every developing country. Off-budget
transfers through patron-client networks to powerful
constituents are a remarkably common mechanism
for maintaining political stability across developing
countries (Khan, 2005b; Khan, 2006b). This is un-
fortunately an inherently corrupt process because
political power is used to benefit particular clients,
and by extension, benefit their political patrons who
stay in power through these mechanisms. While po-
litical scientists and sociologists have pointed out
the myriad different social cleavages around which
patron-client factions are formed in developing coun-
tries, the ubiquity of patron-client factions across all
developing countries regardless of their cultural his-
tories, economic strategies and even their political
institutions demands a more comprehensive expla-
nation.


The common economic problem that develop-
ing countries face in maintaining political stability
in a context of fiscal scarcity provides an important
part of such an explanation. If resources have to be
provided to specific and critical constituencies that
cannot be provided to all deserving groups because
of fiscal scarcity, then these transfers have to be ar-
ranged less than transparently through patron-client
networks. If in addition these resources are not avail-
able in the budget, governments have to raise the
requisite off-budget resources through processes that




16 G-24 Discussion Paper Series, No. 42


are likely to involve corruption or the toleration of
corruption on the part of critical constituents. Thus,
both the raising of resources for political stabilization
and the allocation of at least some of these resources
to critical constituents is likely to involve political
corruption.


While these processes are not desirable and all
developing countries aspire to progress to a stage
where they can be dispensed with, the fact is that
the drivers of these types of corruption have noth-
ing very much to do with the greed or discretion of
public officials even though greed and discretion may
allow some types of corruption to be deployed in
these contexts, and also allow public officials to ben-
efit greatly from these systemic drivers. Rather, as
summarized in figure 7, the main driver of this type
of corruption is the fiscal constraint and the need for
political stabilization, and till the fiscal constraint
can be overcome, the chances of making serious
dents on this type of corruption are likely to remain
rather limited.


However, while patron-client politics and the
associated political corruption are common to all
developing countries, the outcomes of these proc-
esses for economic development are quite different.


Thus, as figure 7 shows, patron-client politics can
sometimes achieve political stability and thereby
allow growth, but at other times it can also fail. The
difference between success and failure is not the
absence of political corruption in some developing
countries, but more subtle differences in the organi-
zation of patron-client politics and the management
of factional demands (for a more extensive analysis
see Khan, 1998; Khan, 2000a; Khan, 2006b).


Our analysis of the drivers of political corrup-
tion is consistent with the persistent evidence of
political corruption in all developing countries. It is
also consistent with the persistent failure of reform-
ing anti-corruption governments in developing
countries. Even when elected on massive popular
mandates and even when they have just replaced very
corrupt governments, reforming governments appear
to succumb to corruption with depressing regularity
within relatively short periods of time. This evidence
suggests that strong structural drivers are at work
and that these are powerful enough to eventually
overcome the intentions of even committed and hon-
est individuals at the highest levels of government.
These experiences should tell us that transparency
and accountability reforms on their own are not likely
to resolve this problem given the financial constraints


Figure 7


DRIVERS OF POLITICAL CORRUPTION IN DEVELOPING COUNTRIES


Political Collapse and
End of Accumulation


Sufficient Political Stability for
Growth and Accumulation to Continue


Politically Driven
Corruption to Raise


Off-Budget
Resources


Political Stabilization using
Off-Budget Resources and


Patron-Client Networks


Severely limited
Fiscal Resources


Poor Economy
(Largely Pre-Capitalist )




17Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


of achieving political stability through transparent
fiscal transfers. We also have many case studies of
corrupt politicians beating honest ones in elections
even when their corruption is well-known and there
is no issue of transparency. The conventional analy-
sis ignores the fact that corrupt politicians can win
because they are often the only ones who can de-
liver, even if delivery in this case means delivery to
selective but critical constituencies.


This argument does not mean that political cor-
ruption is acceptable simply because it is very
difficult to fight it. Nevertheless, it does mean that
the fight against political corruption should be struc-
tured in such a way that it is not doomed to fail, and
that achievable results are attained while keeping an
eye on the long-term goal. There may be important
governance reforms that are needed to ensure that
political stability is maintained and the most dam-
aging aspects of political corruption that seriously
threaten human and social development, or threaten
to destabilize and delegitimize the state are ad-
dressed. The identification of governance reforms
that are appropriate for addressing these problems
has to be a country-specific process, and is not likely
to be helped by broad anti-corruption strategies that
cannot be implemented to any significant extent.


The differences between developing countries
in how they operate their patron-client politics lie in
subtle differences in the organization of political
parties, factions and patron-client groups. Histori-
cal evidence of path changes in economic perform-
ance (for instance in the Republic of Korea in the
early 1960s or in Malaysia in the early 1970s) cor-
relate very well with changes in internal political
organization in these countries that allowed politi-
cal stability to be achieved even if patron-client poli-
tics did not immediately disappear altogether (Khan,
2000a). The conventional governance agenda does
not provide any entry points for developing and
transition countries to identify their governance weak-
nesses in this area or to assist them in constructing vi-
able governance reform packages that can address some
of the more damaging aspects of political corruption.


(c) Weak property rights and the prevalence of
non-market asset transfers


A related structural problem in many develop-
ing countries is that property rights are contested
and weakly protected because of the limited public
resources available for adequately defining and pro-


tecting property rights. In much of the conventional
analysis of governance and corruption in develop-
ing countries, it is implicitly assumed that the
protection of property rights can be dramatically
improved through governance reforms and by re-
ducing corruption. This analysis ignores the economic
fact that constructing a nation-wide system of stable
property rights is an extremely costly enterprise and
advanced countries only achieved significant stabil-
ity in their property rights at a relatively late stage
of their development when most assets had achieved
high levels of productivity (Khan, 2002; Khan, 2004;
Khan, 2006b).


One of the significant conclusions of the New
Institutional Economics introduced by Douglass
North and others was to point out that the protection
and exchange of property rights was an extremely
costly business. These costs were described as trans-
action costs, and New Institutional Economics
pointed out that in advanced economies, transaction
costs may account for as much as half of all eco-
nomic activity (North and Wallis, 1987; North,
1990). An efficient economy has slightly lower trans-
action costs than others, but it never has zero
transaction costs or anything approaching that. In
addition, in an efficient market economy like the
United States, transaction costs may be low for in-
dividual transactors at the point of exchange (this is
the definition of an efficient market) but collective
transaction costs for the economy as a whole are not
low at all. These collective transaction costs can be
paid for because almost all assets in an advanced
country are very productive (by definition) and so
their owners can pay the taxes and incur the private
expenditures on legal and security systems that en-
sure that at the point of exchange, transaction costs
are low. In a developing country, most assets are of
low productivity and cannot pay the cost of their
own protection. It is not surprising that every devel-
oping country suffers from contested and weak
property rights.


Figure 8 shows the drivers of this instability in
graphical form. When most of the assets in a coun-
try have not yet achieved high productivity uses
(which is by definition the case in a developing or
transition economy), it is difficult to imagine how
the protection of property rights across the board
can be paid for. Developing countries have to live
with a much higher degree of property right insta-
bility compared to advanced countries, but this is
not entirely or even largely due to the greed and dis-




18 G-24 Discussion Paper Series, No. 42


cretion of their public officials. When property rights
are not secure to any satisfactory extent, and trans-
action costs at the point of exchange are high,
inevitably many transactions will be too expensive
to conduct through the market. This is why non-mar-
ket transfers are ubiquitous and much more significant
in developing compared to advanced countries.


Non-market transfers include not just the high
profile cases of appropriation and theft using politi-
cal power, but also cases of legal but non-market
transfers through land reform, state allocation of land
for development, and a much more extensive use of
the right of eminent domain in allocating public re-
sources. These processes are structurally necessary
in developing countries but do open up the possibil-
ity of abuse and corruption. But as with patron-client
politics and political corruption, they are not likely
to be stopped by simply addressing the greed and
discretion of public officials as there are deeper struc-
tural factors driving these processes. And as with
patron-client politics, the outcomes of these non-mar-
ket asset transfers can result in a successful transition
to a modern capitalist economy or to predation and
loss of resources to overseas tax havens. The differ-


ence between these two outcomes is not that in one
case there was good governance and in the other there
was not. Rather, the difference is again a much more
subtle set of institutional and political factors that
create incentives and compulsions for public and
private actors benefiting from non-market transfers
to ensure investment in productive enterprises.


The case study evidence strongly supports our
analysis. Whether we look at China at one end of the
growth spectrum or at many other developing coun-
tries in Asia and Africa whose growth rates put them
at the other end of the spectrum, they all share a high
degree of contestability of property rights in their
economies as a whole though with very different
economic outcomes. The differences between them
are subtle in that in countries like China, investors
in productive sectors enjoy considerable stability in
their expectations of protection of future profits (pro-
vided they continue to remain profitable). However,
if we look at property rights across the board, the
majority of asset owners even in China are likely to
face contestable property rights exactly as our analy-
sis suggests. In contrast, in poorly performing countries
the problem is that productive entrepreneurs often


Figure 8


DRIVERS OF NON-MARKET ASSET TRANSFERS IN DEVELOPING ECONOMIES


Resources Captured by
Unproductive Groups:
Economic Collapse


Resources Captured by
Emerging Capitalists:
Emerging Capitalism


Non-Market Asset Transfers
involving political and state actors


Factions and Public Officials
exploiting opportunities


Low-Productivity Economy
(unable to pay for enforcement)




19Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


face great uncertainty about their expectations and
as a result investments are low (Khan, 2004).


Once again, this analysis should not give us
cause for complacency about the importance of gov-
ernance. Rather it should direct our attention to a
more critical set of governance reforms that are able
to create stable expectations for critical sectors to en-
able accelerated investment and growth. In contrast,
trying to implement reforms that attempt to achieve
property right stability across the board in poor coun-
tries that lack the economic resources to make it
feasible is likely only to result in frustration and even-
tually the abandonment of the reform programme.


(d) Predation and expropriation


The most damaging type of corruption in most
developing countries is predatory corruption by the
state where public officials use their political or mili-
tary power to expropriate from citizens. The
patron-client politics of developing countries and
non-market asset transfers have characteristics of
predation even in the best of cases and are always at
risk of descending into a degree of predation and
extortion that obstructs investment and development.
The dividing line between patterns of patron-client
politics that allow political stability to be maintained
and the point at which these processes become so
damaging to development that they are judged to be
primarily predatory is clearly a very grey one. Simi-
larly, non-market transfers of assets often have an
element of predation and extortion for those who


fail to get what they would consider to be fair value
for their assets or are denied access to bid for assets
that others are getting access to.


The critical difference between cases of patron-
client politics and non-market transfers that accom-
pany rapid processes of social transformation on the
one hand and predatory corruption may appear to
be a subtle one. However, a common feature of the
latter countries is the institutional and political frag-
mentation of the state, which has proceeded to an
extent that the state is unable to prevent lower level
functionaries acting to enrich themselves even when
this damages the stability, income and survival pros-
pects of the state itself (Shleifer and Vishny, 1993;
Khan, 1996). When the state is cohesive and its dif-
ferent agencies can be coordinated institutionally and
politically, it is unlikely that “normal” patron-client
politics or non-market transfers will descend into
outright predation. This is simply because higher
agents of the state will in their self-interest restrain
lower level officials or particular agencies whose
appropriation threatens the interests of those higher up.
Nor are the central agencies likely to engage in all-
out expropriation if their time horizon is longer than
the very short ones that are characteristic of leaders
in collapsing states. The critical role of state cohesive-
ness in explaining the difference between straightfor-
ward predatory outcomes is summarized in figure 9.


To the extent that state cohesiveness is a criti-
cal factor explaining predatory outcomes, the
mainstream anti-corruption programme may be se-


Figure 9


CRITICAL DRIVERS OF PREDATION AND EXTORTION


Expropriation and Predation
inducing collapse of productive


sectors


Weak Protection of Assets and
Incomes


Political Factions seeking to
Capture Assets and Incomes


Fragmentation of Central
State




20 G-24 Discussion Paper Series, No. 42


riously missing the critical problems in some of the
most poorly-performing developing countries. In
these countries, transparency, salary increases or
anti-corruption watchdogs and aid penalties are un-
likely to have any significant effect at all. The
appropriate policy focus in these vulnerable states
should be to strengthen the state’s capacity to be-
have in a cohesive and effective way. In other words,
the agenda in these countries should focus on con-
structing a Hobbesian state in a context where the
state is falling apart rather than to focus on Adam
Smithian reforms of limiting the freedom of the state
(Khan, 2005a). The latter agenda is very strongly
based on the greed plus discretion explanation for
the myriad problems besetting poorly performing
developing countries.


Our argument is that the descent into predation
in some of the weakest developing countries is not
primarily caused by the greed and discretion of their
public officials but rather by the inability of their
public officials to impose and enforce social order.
In these countries, reforms based on a partial and
limited analysis of the drivers of corruption can end
up further weakening already weak states by further
limiting state capacity to act in decisive ways. This
analysis does not reject the argument that state le-
gitimacy is very important and a state that is acting
in arbitrary ways is unlikely to be able to impose
social order. But the focus of reform and in particu-
lar of anti-corruption reform should carefully identify
the major drivers of the problem and take adequate
steps to address the most important problems.


Our discussion of the different drivers of cor-
ruption in this section can help to explain the appar-
ent paradox that all developing countries appear to
have high levels of corruption and they all fail in
terms of good governance at early stages of their
development. We can explain these observations by
recognizing that many of the drivers of corruption
and poor governance (such as weak property rights)
are structural and therefore not entirely avoidable in
any developing country. Nevertheless, the high-
growth countries obviously possessed governance
capacities that allowed them to avoid the most dam-
aging aspects of these structural drivers.


Policy Implications


Our analysis suggests that policy based on the
greed plus discretion analysis of corruption is only
relevant where the drivers are indeed primarily the


ones identified in these theories. Thus, in cases of
unnecessary red tape and other useless interventions
by the state, where the purpose of the intervention is
only to create opportunities for public officials to
extract from society, the conventional policy agenda
of liberalization, salary increases, rule of law and
transparency would be very relevant. However, given
the other drivers of corruption, it is unlikely that these
reforms could be implemented to an extent that any
observable decline in corruption would follow. This
is in fact what we observe when these programmes
are implemented. However, there is no reason why
unnecessary red tape and other damaging interven-
tions should not continue to be targeted and removed
in developing countries.


In terms of necessary state interventions, the
reform agenda should be quite different. The his-
torical observation is that successful states suffered
from some corruption in these areas, but they had
strong state capacities that ensured that the desired
outcomes were achieved and the cost of corruption
was not big enough to wipe out the net benefit. In
contrast, less successful states could not perform
necessary functions effectively and the corruption
in these areas was therefore extremely damaging
because they added a rent seeking cost to an already
poor outcome. We have argued that the reform
agenda in this area should be to strengthen state ca-
pacities and legalize and regulate the associated rent
seeking.


In the area of political corruption, all develop-
ing countries have to endure levels of corruption that
are not desirable in the long run and they have to
take active steps to limit this over time by increas-
ing fiscal redistributions to maintain political stability
in a transparent way. However, in the meantime, the
reform priority has to be to limit the damage done
by political stabilization through patron-client net-
works. In some countries this may mean restructuring
these political arrangements though this is obviously
a discussion that developing countries have to have
internally.


The instability of property rights and the asso-
ciated corruption is also a problem affecting every
developing country but high-growth ones clearly had
the institutional capacities to ensure stable expecta-
tions in critical growth areas. The reform priority
for other countries must be to learn from these ex-
periences to develop the necessary governance ca-
pacities even though acceptable levels of property




21Governance and Anti-Corruption Reforms in Developing Countries: Policies, Evidence and Ways Forward


right stability across the board may not be achiev-
able for many years.


Finally, predation is the most important risk for
developing countries. All successful countries were
able to avoid predation and extortion to any signifi-
cant extent because they had strong states that could
limit the degree to which lower officials or private
looters in association with local officials could op-
erate to the detriment of the state. There are no
examples of rapid and sustained development with
states that lacked the ability to impose social order,
but there are many examples of rapid growth in states
that suffer from some corruption. The critical reform
message here is (paradoxically) to strengthen state
enforcement capacities in states that are threatened
with predatory state behaviour rather than to dis-
mantle states that are obviously not working.


5. Conclusions


The governance and anti-corruption agenda that
is increasingly championed by international agen-
cies like the World Bank identifies critical goals that
all developing countries aspire to. There is no ques-
tion about the desirability of good governance. The
questions raised in this paper are really about:


(i) the extent to which these are not just goals of
development but also necessary governance
preconditions for development,


(ii) whether they can actually be achieved in de-
veloping countries, and


(iii) whether a focus on these governance issues is
taking our eye off more important and achiev-


able reforms that will enable the goals of good
governance to be achieved faster.


Our analysis seriously questions whether the
governance agenda can be interpreted as a precon-
dition for development rather than being a list of
important and desirable objectives. We also argue
that there are strong structural drivers of corruption
and weak property rights that mean that these goals
are unlikely to be achieved to any significant extent
in any developing country, regardless of economic
performance. There is a real danger that these struc-
tural drivers are not being properly understood. The
desire to link lending and partnership with develop-
ing countries on the basis of small differences in
governance and corruption indicators is seriously
misguided according to our analysis. Apart from the
subjectivity of these indicators and the possibility
of manipulation, our argument is that small differ-
ences in these indicators tell us nothing at all about
development prospects of developing countries.


Instead, we argue that we need to identify criti-
cal governance capacities on a country-by-country
basis to accelerate economic and social transforma-
tions in developing countries. We also need a frame-
work for distinguishing between types of corruption
so that we can set realistic and feasible national in-
stitutional reform priorities and anti-corruption strat-
egies. And finally we argue that by focusing on a
long list of unachievable goals as immediate reform
priorities, we are losing the opportunity to carry out
critical reforms that enhance the chances of devel-
oping countries moving from diverging to converg-
ing status, or remaining sustainably in the converging
group once they have enjoyed a growth spurt. On
the contrary, this reform agenda is in serious danger
of creating disillusionment and reform fatigue as its
goals are unlikely to be achieved.




22 G-24 Discussion Paper Series, No. 42


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