The
subject of ethics has increasingly been present in economic
analysis, although
not without considerable debate. Some economists believe that the
importance of economics is purely technical. Others believe that
moral considerations in economic analysis provide a more accurate
picture of possible outcomes since it takes into consideration the
human aspect of economic actors--that is, people.
I
confess that, as an economist, it makes me nervous to insert
subjective measures such as morality and ethics when I do my own
analysis, both because my conclusions may be applicable only to a
few cases and because morality and ethics are hard to measure. But
since economics is the study of choice, human behavior cannot be
ignored in economic analysis if we want to have a meaningful
insight into people's economic life.
I
will try to explain corruption, therefore, in economic terms and
show how economic freedom removes opportunities for corruption and
promotes ethics not just for its moral implications, but also
because of its economic value.
Ethics, according to Merriam-Webster's
dictionary, is "the discipline dealing with what is good and
bad...." In general, we call unethical those actions for which
there is a social consensus that they are a bad thing.
Corruption has several meanings, depending
on whether it takes place in the public or private sector; however,
for most people corruption is something unethical, something
considered a wrongdoing. A closer look at human behavior in
economic life suggests that, in some instances, corruption does not
reflect so much a lack of ethics as it reflects a lack of economic
freedom.
Economic Freedom and Corruption
To
better understand the link between corruption and economic freedom,
let me first describe economic freedom and then explain how its
absence fosters corruption. I will examine the relationship between
economic freedom and corruption both in the form of informal
economic activity and in the public-sector bureaucracy.
According to The Heritage Foundation/Wall
Street Journal annual Index of Economic Freedom, economic freedom
is "the absence of government constraint or coercion on the
production, distribution, or consumption of goods and services
beyond the extent necessary for citizens to protect and maintain
liberty itself."
The
Index measures the level of economic freedom in 161 countries
around the world. To measure economic freedom, it focuses the study
on 10 different factors:
- Trade policy,
- Fiscal burden of government,
- Government intervention in the
economy,
- Monetary policy,
- Banking and finance,
- Capital flows and foreign investment,
- Wages and prices,
- Property rights,
- Regulation, and
- Informal market.
The
Index provides a framework for understanding how open countries are
to competition; the degree of state intervention in the economy,
whether through taxation, spending or overregulation; and the
strength and independence of a country's judiciary to enforce rules
and protect private property. The 10 factors of the Index allow
anyone to see how much or little economic freedom a country
has.
Some
countries may have freedom in all factors; others may have freedom
in just a few. One of the most important findings of the Index is
that, as Frederick von Hayek foresaw more than 60 years ago,
economic freedom is required in all aspects of economic life--that
is, in all of the 10 factors--in order for countries to improve
their economic efficiency and, consequently, the living standards
of their people.
The
Index shows that corruption does not always reflect inherent
unethical behavior. This is particularly the case for those who are
forced out of the formal economy into the informal economy through
burdensome regulations, taxation, and weak property rights.
Economic Freedom and the Informal
Economy
Charts 1 and 2 illustrate the relationship
between economic freedom and the size of the informal economy as a
percentage of GDP in OECD [Organisation for Economic Co-operation
and Development] countries and 22 transition economies. Chart 1 shows a
positive correlation between these two factors. As economic freedom
vanishes, the informal economy takes a larger share of GDP.
On
average, as shown in Chart 2, the size of the informal economy in
economically unfree and repressed economies is almost three times
the size of the informal economy in free economies, and almost
double the size of the informal economy in mostly free
economies.
These charts illustrate the perverse
effect of economic repression on the ethics of ordinary people and
on the perpetuation of their poverty conditions. For example, in
most developed countries, people have a better standard of living
thanks to credit access. In the United States, for example, without
credit, I would not have a house, or a car, or a TV, or a vacation,
or many of the products that add comfort and convenience to my
life. Credit makes it possible for me, an ordinary middle-class
person, to improve my standard of living in many ways.
To
have access to credit, however, I need to prove that I have an
income or property. To prove that I have income, I need a formal
job, and to prove that I have property, I need a property
title.
The
amount of available formal jobs depends, of course, on how easy or
difficult it is for people to invest, whether in a small retail
shop to sell groceries or in a big factory. The friendlier the
business environment, the more likely formal jobs will be
available. According to the Index of Economic Freedom, however, in
most low- to middle-income countries, it is extremely difficult for
small and medium investors--which are the largest source of
jobs--to operate, both because of the regulatory environment and
because of the lack of a strong rule of law.
Consider labor regulations in Argentina.
In this country, an employer must grant, by law, several employee
benefits, including holidays, vacations, sick leave, health
insurance, paid overtime, an annual bonus, and some paid months
before laying off an employee. Or take France, where employers must
grant, by law, at least 2.5 working days of paid vacations per
month; pay over 30 percent in contributions to social security;
offer a complementary pension scheme, 35 hours of work per week,
and time off; and abide by a burdensome bureaucratic procedure to
dismiss employees.
The
immediate problem with this kind of legislation is that it assumes
that all employees are equally good, equally responsible, and
equally productive, which is not true. If the employee arrives
late, treats customers poorly, and makes the employer lose money,
the law grants that employee the same benefits that it grants to a
good employee.
Perhaps large businesses, like a
multinational factory, can afford to comply with these regulations
because of the size of the business and its diversification around
the world. But the burden of these regulations destroys small and
medium entrepreneurs, who may put their entire savings at stake in
their investment.
Small and medium businesses therefore
choose to do business and create jobs in the informal sector, where
these benefits are negotiable and tied to performance, and not
forced by law. This is a clear case in which the rules of the state
create perceived unethical behavior by private employers and
employees when what is really in question is the ethics of such a
regulatory burden in the first place.
If
they do not have a job, people can still get access to credit if
they have a property title to use as collateral. According to
Peruvian economist Hernando de Soto, many of the poor in the
developing world have property but the bureaucracy they have to go
through in order to get a property title is, at best, huge. For example, in
Perú, "to obtain legal authorization to build a house on
state-owned land took six years and eleven months, requiring 207
administrative steps in 52 government offices.... To obtain a legal
title for that piece of land took 728 steps."
It
is just as bad in other countries, such as Egypt, where it takes 77
steps in 31 government offices (anywhere from six to 14 years), or
the Philippines, where it takes 168 steps through 53 offices
(anywhere from 13 to 25 years). The poor own many things that they
could use as collateral, but it is bureaucratically impossible for
them to validate their property rights. As a result, they are
unable to convert what they own into capital and, therefore, raise
their standard of living.
Informality is a response to economic
repression, not to something inherently unethical in those who
circumvent legislation. What is most unethical about informality is
the condition in which the government forces the poor to live.
Informally employed people are condemned to a standard of living
that is significantly lower than that of formally employed people,
who have credit access. Also, informality creates a culture of
contempt for the law and fosters corruption and bribery in the
public sector as a necessary means to navigate the bureaucracy.
Economic Freedom and the Rule of Law
Charts 3 and 4 illustrate the relationship
between economic freedom and the level of corruption in 95
countries around the world. Chart 3 shows a strong correlation
between these two factors. As economic freedom vanishes, corruption
flourishes. On average, as shown in Chart 4, the level of perceived
morality--as a contrast to corruption--in economically free
countries is almost four times the level of perceived morality in
the public sector in mostly unfree or repressed economies, and
almost 60 percent greater than in mostly free economies.
Having a weak rule of law significantly adds to the
level of corruption in the public sector as well as the amount of
informal activity. A weak judiciary is a "blind eye" on anything
done outside the law. With a weak judiciary, corruption goes
unpunished and informality flourishes.
This
is one of the most serious problems we find in the world today. Of
161 countries evaluated in the 2003 Index of Economic Freedom, 108
received bad scores in both regulation and property rights,"
undermining any effort to improve the living standards of the
poorest in those 108 countries.
Conclusion
To
be sure, there are cases of corruption that respond to the
unethical nature of the corrupt individual. But for the most part,
the unethical behavior stems from the environment in which
individuals must interact. Convoluted regulations and weak rule of
law foster a culture of corruption and informality both in the
private and public sectors.
In
the public sector, convoluted regulations and weak rule of law
provide ample opportunities for public officials to accept bribes
without punishment. In the private sector, those two factors push
some people to do business informally as a means to survive and
others to profit far more than they would if the possibility of
bribery did not exist. The result is an increasingly unequal
society, in terms of the opportunity to create wealth and improve
living standards.
To
fight corruption and informality, it is essential to understand
that corruption is a symptom--of overregulation, lack of rule of
law, a large public sector--not the root of the problem. The
perceived problem is unethical/corrupt behavior of the private
sector, which leads the government to press more on private-sector
activities. The real problem is the government action/regulations
causing undesired behavior of the private sector. The optimal
solution would be to eliminate burdensome regulations so that
unethical behavior does not occur.
Countries must advance economic freedom in
all possible areas of the economy, with particular emphasis on
regulations affecting small and medium business, in order for
corruption and informality to decrease. The Index of Economic
Freedom is an excellent guide to identify what is obstructing
economic activity and, therefore, perpetuating poverty.
Countries must also preserve the
independence and effectiveness of the judiciary to punish corrupt
actions. Economic freedom with a strong rule of law will foster a
culture of investment, job creation, and institutional respect--all
essential factors in massively improving the living standards of
ordinary people.
--Ana Isabel Eiras is Senior Policy
Analyst for International Economics in the Center for International
Trade and Economics at The Heritage Foundation. These remarks were
delivered at a conference on the "Ethical Foundations of the
Economy" in Krakow, Poland.