Cameron Luke Wilson

Annexure C – Cover Page SCHOOL OF ECONOMICS Course –​ ECO3020F CLASS ESSAY Allocated Essay Number: ​527 Student Name & Surname: ​Cameron Wilson Student Number: ​WLSCAM003 Word count: ​1959 Tutorial Group number: ​12 Due Date: ​ 10 May 2017 Declaration 1. I know that plagiarism is wrong. Plagiarism is to use another’s work and pretend that it is one’s own. 2. This paper is my own work. 3. I have used the ​UCT Author-Date​ convention for citation and referencing. Each significant contribution to, and quotation in, this paper from the work(s) of other people has been attributed, and has been cited and referenced. 4. I have not allowed, and will not allow, anyone to copy my work with the intention of passing it off as his or her own work. Signature: ​Cameron Luke Wilson WLSCAM003 Date: ​- Word Count: ​1959 Annexure C – Cover Page Corruption in South Africa Cameron Wilson April 2017 Abstract This essay looks at the economic, fiscal, and social costs of corruption in a South African context whilst equally drawing from international studies. Corruption has negative impacts on gross domestic product (GDP), investment, the poor as well as on the governance of a country. This essay will deal with the issues faced by developing countries regarding corruption and will argue against the idea that corruption is necessary for an efficient private and public sector. Finally, this essay will demonstrate the various models used to understand corruption and the implications it has on an economy, whilst exploring various mitigation strategies that can be used against corruption. 1. Introduction Corruption is the inducement to wrong by improper or unlawful means (Merriam-Webster.com) and is perceived to be a blight on the economic development and growth of all nations. The problem of corruption is not a new one and many economists have set out to understand the effects corruption has on an economy. Quantitative data regarding the overall effects of corruption has only recently been gathered to complete regression analyses which provide a stark relationship between corruption and various economic factors which make up a nation’s economy (Dreher & Herzfeld, 2005:1). Such factors will be discussed as well as the implications corruption has on the growth of an economy; and how best to mitigate the problem of corruption. 2. South Africa and Corruption: An Overview Corruption Watch, a not-for-profit organisation, provides a platform from which South Africans can report corruption. The organisation “celebrates whistle-blowers who have risked their reputations and jobs” to shine a light on the frequency of corruption within South Africa (Corruption Watch, 2016:3). The organisation has received 14 972 corruption complaints since 2012. Corruption Watch received 4 391 corruption complaints in 2016 with 61% of these reports being “classified as corruption” by Corruption Watch (Corruption Watch, 2016:13). The notable hotspots of corruption include the Education sector, Road Traffic sector, Licensing Department, Immigration Department, and Housing sector (Corruption Watch, 2016:13). It is troubling to see how corruption is found in sectors that lay the foundations for South Africa’s economy. More importantly, the participants in these sectors and departments come from previously disadvantaged and impoverished backgrounds. Thus, it is important to understand what the effects of corruption are on the poor through these sectors. 3. Economic Costs of Corruption 3.1 Corruption and the Poor As of the second quarter in 2016, South Africa’s average wage for low skilled labour was ZAR3650,00 per month whilst the living wage per individual per month was ZAR7222.50 (TradingEconomics.com). South Africa is one of the most unequal countries in the world with a GINI coefficient (income per capita including salaries, wages, and social grants) of 0.69 as of 2011 (Lehohla, 2014:14). Thus, it is conclusive that most South Africans work a low skilled job which gives indication to how severe the poverty in South Africa is. Increased corruption in sectors that are critical for most South Africans could have severe implications on the poor. Shown below is the housing index of South Africa which has a base year of 1960. The index is correlated with the corruption perception index (CPI) from 2009 and onwards, since President Jacob Zuma’s African National Congress (ANC) took power. This correlation between the housing index and the CPI is grounds for further investigation on how corruption in the housing sector is responsible for accelerating price increases. Figure 3.1: South Africa Housing Index, 2007-present. (TradingEconomics.com) Figure 3.2: South Africa Corruption Perception Index, 1996-present. (TradingEconomics.com) Corruption in the utilities sector is also shown to be anti-poor as it is responsible for diverting funds away from public projects resulting in a deadweight loss to society (Lovei & McKechnie, 2000:8). 3.2 Corruption and Investment Corruption is linked to a decline in foreign direct investment (FDI). This can be explained by the nature of corruption. Competing firms that pay bribes for tenders push the cost of transacting up, thus making investment costlier to private entities (Campos, Lien & Pradhan, n.d.:13). More corrupt governments tend to have lower FDI especially if the state has monopolised utilities and other sectors (Campos et al, n.d.:14). Such with the case of South Africa and Eskom (energy sector), FDI in the energy sector is low for South Africa with most investment in the energy sector coming from the government through tax payers’ funds (OECD.org). 4. Fiscal and Social Costs of Corruption Corruption leads to lower public revenues to the state. This is attributable to administrative corruption which is prevalent in tax collection and customs payment. The reduced payments of taxes and customs fees due to “corporate favours” results in a loss of revenue for the state (WorldBank.org, n.d.:21). The loss of revenue to the state through corruption means the government has less resources to promote economic expansion through fiscal policy. If the government desires to expand the economy through expenditure, its impact will be limited without debt financing. The limited impact of fiscal policy adversely impacts economic growth through increased reliance on expansionary monetary policy (which has negative effects on the exchange rate and rates of interest), debt financing and poor public service delivery. These inefficiencies in fiscal expansion, due to loss of revenue, negatively affect society. It is evident that the inability to efficiently implement fiscal policy results in poor growth, service delivery and job creation, thus having undesirable outcomes for the poor. Corruption could be a contributing factor to inequality in transitioning countries as governments redistribute resources to private firms with little of the “once social assets” being redistributed to the poor (WorldBank.org, n.d.:21) 5. Corruption Models 5.1 Cobb Douglas Measuring corruption is difficult due to the nature of corruption. It is said to be caused by a multitude of factors including a “deeper set of policy distortion, institutional incentives and governance.” (Farida & Ahmadi-Esfahani, 2007:2). Due to the difficulty of measuring corruption, perception-based models hold little relevance, thus experience-based indicators prove to be more beneficial for data collection to build effective models of corruption (Farida & Ahmadi-Esfahani, 2007:3). Below is a list of models used to understand corruption. The list shows the uses and pitfalls of these models. Corruption Models Approach Scholars Models Limitations Findings 1) Economic growth It explores the relationship between corruption and economic growth 2) Game theory It identifies the conditions that are necessary for corruption and those that are conductive to it (Murphy 1993) (Mandapaka 1995) (Triole 1996) (Mauro 1997) (Bardhan 1997) (Hellman 2000) Lucas type Subjective Surveys Rent Seeking Endogeneity bias Keynesian Sample size sensitivity Only few were able to empirically prove the negative relationship between corruption and growth 3) Multiple indicators multiple causes It considers observable data on potential indicators to predict values for unobservable (corruption 4) Simulation It tests the effectiveness of some proposed solutions to combat corruption (Andvig 1990) (Laffont, 1991) (Basu 1992) (Mookherjee 1995) (Dixit 1997) (Elliot 1997) (Acemoglu 2000) (Weck 1983) (Frey 1984) (Balasa 1985) (Salvatore 1991) (Greenaway 1994) (Loayza 1996) (Schneider 1997) (Giles 1999) (Turnovsky 1995) (Jain 1998) (Stapenhurst 1999) (Hammond 2000) (Luna 2002) (Situngkir 2003) Neoclassical Principle / Agent Models the demand side Heterogeneous Bureaucrats (Agents) Ignores the government involvement LISREL MIMIC Corruption occurs in continuing relationships Co-linearity between indicators Weak estimation techniques This approach yields some useful insights into the notion of corruption The output of this model is a time series index that can be used to construct ordinal and cardinal time series of corruption Lacks structural interdependence Agent-based No way to detect unstable equilibrium Total convergence is not achieved in finite time Many showed the strength of the cause-effect relationship between corruption and growth Table 5.1: Comparative corruption model table (Farida & Ahmadi-Esfahani, 2007:4) Farida and Ahmadi-Esfahani use an extended Solow growth model which includes human capital and indirect effects of corruption, output, and growth. This model assumes one good produced with a neoclassical production function which is positive and has strictly diminishing marginal product of physical labour. Y​t​ = ​K​t​α ​H​t​β​ [G​t​ (ρ) L​t​]​ 1 – α – β Where: Y​t​ = ​Aggregate level of income K​t​ = Level of physical capital H​t​ = Level of human capital L​t​ = Amount of labour employed G​t = ​ Level of government expenditure ρ = Level of corruption in the country 0 < α, β < 1 (Farida & Ahmadi-Esfahani, 2007:7) This adjusted Solow growth model is a Cobb-Douglas production function and measures the effect of corruption on output. However, this model requires accurate data to estimate the level of corruption and its effects on an economy. Such proxies for these data come from various sources to get a reliable mean (Farida & Ahmadi-Esfahani, 2007:14). 6. Mitigation Strategies Preventing corruption is a challenge as it is a form of underground economic activity; and underground economic activity is difficult to measure. Organisations such as Corruption Watch or Transparency International rely on perception-based reports as well as experience-based reports to develop mitigation strategies against corruption. Such perception-based research gives rise to the corruption perception index (CPI) as viewed below. The CPI is measured on a scale from 0 – 100, 0 being very corrupt and 100 being very clean. Corruption Perception Index (World) Figure 6.1: Corruption Perception Index of the World (Transparency.org) The knowledge of the CPI of a country can give respective governments and authorities an idea of what policies to implement or what actions to take to battle corruption. South Africa is ranked the 64​th least corrupt nation in the world out of 176 nations with a CPI score of 45/100 (Transparency.org) The IMF has put together a team that has proposed several mitigation strategies regarding corruption. The team, supervised by Sanjeev Gupta and Ceda Ogada strongly suggest transparency, achieved by a “holistic and multifaceted approach” dependent on the country’s circumstances, be implemented first (International Monetary Fund (IMF), 2016:15). The team suggests a systematic approach from an adjustment of social expectations to macroeconomic policy (IMF, 2016:20). The IMF has resorted to more extreme methods such as “suspending IMF lending due to corruption concerns” (IMF, 2016:16). Examples include Ukraine in February 2016 and Malawi in November 2013 (IMF, 2016:16). Not-for-profit organisations embedded within the foundations of society also play a role in mitigating corruption. Groups such as Corruption Watch have helped bring to light the corruption in South Africa, thus creating greater transparency for the nation. 7. Recommendations As discussed above, corruption adversely affects the poor. It undermines a nation’s ability to reach full employment because it results in an inefficient and unfair redistribution of resources. Corruption needs to be fought from the foundations of society, eliminating it from the key sectors that drive economic growth. The first step would be educating the populace about their rights. It is imperative that citizens have equal access to the judiciary system; equally important, the judiciary system needs to be independent from ruling parties. The independence of the judiciary from the state, equal access to the law for every citizen, and adequate constitutional-rights education will lay the foundation for transparency policies to be implemented. Such policies to be implemented include a transparency charter and an anti-corruption charter. These charters will provide the legal framework from which corruption will be challenged. Economically, policies can be implemented that will free the market for private participants. This disincentivises private participants from going through government officials illegally to speed up administrative processes. Freeing up regulations will also allow not-for-profit organisations, such as Corruption Watch, to operate more effectively in the market ensuring greater progress in transparency efforts. 8. Conclusion Corruption is the inducement to wrong by improper or unlawful means. It impedes economic growth due to inefficient and unfair redistribution on once-owned social resources. Not-for-profit organisations such as Corruption Watch actively strive for transparency by providing a platform for reporting corruption. South Africa finds itself in a vulnerable position as it has one of the highest Gini coefficients in the world, with most of its citizens living in poverty. The adverse effects of corruption heighten this vulnerability. Corruption threatens the foundations of society which negatively affects economic growth. Corruption leads to fiscal inefficiencies that cost the government the ability to fully implement effective expansionary policies. Corruption also affects FDI adversely. The additional risk perceived by investors puts the country in a negative light. Private firms do not want additional costs of investing due to corruption. State capture of utilities results in the monopolisation of utilities thus creating barriers of entry for potential investors. This results in most of the investment required for these monopolised utilities to come from state coffers, thereby creating additional fiscal costs. There are several models used to measure the effects of corruption; however, most of their pitfalls come from lack of complete data. This is due to the underground nature of corruption. Corruption can be modelled in a Cobb-Douglas production function which, again, is limited due to incomplete data. The IMF has suggested a multitude of mitigation strategies, from social expectations to suspension of IMF lending to corruption prone nations. It is suggested that transparency be achieved through not-for-profit organisations and education. Corruption needs to be reduced to promote economic growth efficiently. Once the social and legal foundations are laid to promote anti-corruption policy and transparency policy, can corruption be tackled effectively through a sound constitution and an independent judiciary system. Reference List Corruption Definition, Merriam-Webster. Available: https://www.merriamwebster.com/dictionary/corruption [2017, May 01]. Dreher, A. & Herzfeld, T. 2005. The economic costs of corruption: A survey and new evidence. Available: http://library.wur.nl/WebQuery/wurpubs/fulltext/52902 [2017, April 27]. Corruption Watch. 2016. Annual report 2016. Volume 1. Issue 1. 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