Corruption, Perception and Foreign Direct Investment

Counting the cost of graft


Hennie van Vuuren
Senior Researcher with a focus on Anti-Corruption Strategies at the ISS

Published in African Security Review Vol 11 No 3, 2002


Bribery undermines human development and a transition to stable democratic rule. It props up illegitimate regimes as corporations bid for contracts by bribing, in a seeming race to the bottom. The world’s wealthy are slowly waking up to this and criminalising this scandalous practice of bribing foreign public officials. However, such measures, if enforced, need to be combined with domestic anti-corruption strategies in the South. If this opportunity is missed, the risk of investing private capital in marginalised economies perceived to be highly corrupt is further upped, making investment-driven economic growth possibly even less unattainable.

Introduction

The destructive phenomenon of corruption and its apparent pervasiveness, both perceived and experienced, is perhaps best described by Kofi Annan as being:
especially destructive in developing countries with their delicate economic situations. It has critically hobbled and skewed Africa’s development. There is no point in pretending that this is not true. Addressing the problem of corruption requires targeting both payer and recipient … African governments in particular must … make the fight against corruption a genuine priority. The costs of not doing so are very high in lost resources, lost foreign investment, distorted decision-making, and failing public confidence.1
Although often lamented as being a modern condition, other African scholars in the pre-modern era warned against the danger posed to societies that allow graft to prosper. As far back as 1400 BCE, the Egyptian-born Moses indicated: “You must not accept bribes for a bribe blinds the eyes of the wise and subverts the cause of those of who are right.”2

If not a product of modernisation then the frequency and scale of corruption3 has surely been greatly exacerbated by the rapid pace of globalisation.4 It has become easier for corrupt regimes to transfer the proceeds of illicit gain to banks and offshore centres largely undetected (although measures are now being implemented to tackle this). Greater emphasis is also placed on the need for governments, particularly in the South, to provide incentives that attract foreign private capital—viewed as a way to kick-start economies in tandem with the privatisation of state-owned assets. Privatisation and large-scale procurement deals often provide little provision for oversight from civil society to ensure that the proceeds of these massive capital transactions reach the treasury and not a corrupt public official prone to looting state reserves.

Globalisation also places pressure on various aspects of society to standardise practice in uniquely different parts of the planet. Standardisation smoothes the wheel of trade and capital mobility. It is rightly argued that this process often works in the interests of a global elite allowing Coca-Cola and McDonald’s to become symbols of consumption and by default of culture—largely to the detriment of positive elements in existing custom and tradition.

However, globalisation has produced additional losers who very few mourn. Since the early 1990s business has started to count the cost of corruption—particularly of ‘grand corruption’. This frequently involves very large international bribes and hidden bank accounts. Grand corruption should be distinguished from demands for smaller payments in return for services, referred to as ‘survival corruption’. More commonly known as petty corruption, this latter form of corruption is often more reflective of an underpaid, or unpaid, public sector which is also frequently severely demoralised as a result. Grand corruption appears to have gained frequency and the amounts of money demanded by corrupt officials is seen as an increasingly inhibitive form of ‘taxation’ for companies who are driven by shareholder demand for greater profit margins. The arms sector may provide some clues to understanding the ‘incentives’ that multinational companies are prepared to pay, which in turn drive corrupt officials to act injudiciously with national treasury resources. A report released by the UK Chapter of Transparency International5 (TI-UK) places a conservative estimate of the level of ‘commissions paid’ at 10%, in an industry worth an estimated US$40 billion a year.6 The report also estimates that these ‘commissions paid’ (US$4 billion) make up approximately 50% of the bribe money paid annually by multinational companies abroad.

Clearly, corruption is big business. Civil society initiatives to raise awareness of the issue have found support from multilateral financing institutions such as the World Bank, which treated the subject as a taboo for decades. The issue finally gained prominence as an impediment to development in the 1990s.7 This followed decades in which corruption had largely been tolerated to the extent that it was almost encouraged, particularly in developing countries such as Zaire (present day Democratic Republic of Congo–DRC) under the kleptocrat Mobutu. His particularly robust form of ‘politique du ventre’8 took place under the watchful eye of his sponsors in Washington.

Attempts to combat corruption are now commonplace and most countries have some strategy—with varying degrees of enforcement and success—to combat the practice of bribery and corruption. The standardisation of business practice as discussed earlier has also increased pressure on countries to combat corruption as it serves as a barrier to capital flows—largely because it induces a level of uncertainty in transaction costs. This paper will seek to address recent initiatives taken at an international level to combat corruption and more importantly the supply side of corruption—bribery.

These initiatives, although seeking to punish bribe-payers, also place an additional ‘risk’ on doing business in countries, which are perceived as highly corrupt. This should, of course, be seen within the context of the negative effect corruption—and particularly perceived levels of corruption—have on foreign direct investment (FDI) flows to the South. We in turn also look at the relevance of FDI to economic growth in the South and the problematic nature of relying on perception-based surveys to inform investor decisions.

The essay argues that any international strategy to combat corruption must be coupled with effective domestic strategies in order for all countries in the South to win from such a process. Alternately, measures meant to punish bribe-payers abroad could have the unforeseen side effect of further marginalising the least developed economies, particularly in Africa, by making them destinations that are completely side-stepped by capital from the North. The effects of this will do little to undo the economic havoc created by the present lethal cocktail of corrupt regimes, corrupting multinational corporations and failed economic policy too often dictated by international finance institutions.

International anti-bribery initiatives

The flip-side of demand driven corruption by foreign public officials is bribery—the supply side of the equation. As George Soros correctly points out, “international business is generally the main source of corruption”.9 Attempts to criminalise bribery and thereby not only focus on the actions of corrupt public officials, are relatively recent.

The Organisation for Economic Co-operation and Development (OECD) Convention on combating bribery of foreign public officials in international business transactions10 (hereafter referred to as the OECD Convention), was signed into force in February 1999, and by May 2002 it had been ratified by 34 of the 35 signatory countries. These countries account for more than three-quarters of global trade and are regarded as the group of the world’s wealthiest countries. The OECD Convention outlaws the bribery of foreign public officials by punishing officials who pay these bribes in their home country if found guilty of the following transgression:
To offer, promise or give any undue pecuniary or other advantage, whether directly or through intermediaries, to any foreign public official, for that official or for a third party in order that the official act or refrain from acting in relation to the performance of official duties, in order to obtain or retain business or other improper advantage in the conduct of international business.11
The signatories of the OECD Convention are required to go a step further than symbolically signing it. They are bound to create national implementing legislation, which will ensure that the provisions of the code are implemented. Once again, many countries have taken the necessary steps to ensure this, however, anti-bribery legislation remains largely untested and large parts of the business community in particular, remain uninformed of its existence.
According to the TI Bribe Payers Index (BPI) released in May this year:
… in 2002, three years after the Convention came into force, only 7% of respondents12 were familiar with the Convention while 12% stated that they knew something about it. This is the same combined figure as in the first BPI, conducted in 1999.13
It may be argued that such poor awareness could be expected of legislation, based on an international agreement which is only a few years old. However, given estimates of the extent of bribery, the law is probably being breached on a daily basis by multinationals.

The OECD Convention is not the first piece of legislation of this kind; it is preceded by the US Foreign Corrupt Practices Act (FCPA), which was already enacted in 1977. The FCPA was enacted in the wake of the US Watergate scandal and evidence that had been presented to the US Securities and Exchange Commission (SEC), which showed large-scale bribery abroad by corporate America.14 The FCPA is in many ways the model legislation on which the OECD legislation is based, but has up till now delivered far less than US lawmakers promise. There has been only one non-resident indicated for violating the law and the US Department of Justice brought only 30 cases involving bribery to court.15 This is bad news for attempts to combat bribery abroad. One of the greatest disincentives for corporations to bribe is the concern that they will either risk embarrassing fines which their shareholders are unlikely to approve of, or even worse—if the director of a multinational corporation is found guilty of bribing a foreign public official—the threat of a jail sentence.

The reasons for the lack of enforcement are not immediately evident, however, US companies may have honed sophisticated methods to circumvent the FCPA. Examples of these could include ventures unconnected to the contract they seek in which public officials or family members operate as silent equity partners. Whatever the reason, according to the TI BPI, businesspeople rank the US’s propensity to bribe above that of many European Union (EU) competitors, including France. French business is infamous for its willingness to pursue business by the payment of bribes in both parts of Africa (most recently exemplified by the involvement of former French President Francois Mitterand’s son in dubious arms deals in Angola) and Europe (Elf Equitanne’s donations to German Chancellor Helmut Kohl’s Christian Democrats in return for lucrative contracts). Even more worrying is the perception that US corporations’ willingness to bribe has in fact increased since the first BPI was conducted in 1999.

US firms are not alone in this practice. Apparently enlisting the help of sophisticated listening devices such as Echelon (the keyword-sensitive e-mail ‘listening’ device developed by the US National Security Agency—NSA), senior US officials, according to recent reports by the State and Commerce departments, have been:
… eavesdropping to maintain and update a top-secret database of international bribery cases. This information is being used as leverage to help American companies compete abroad and is being matched by similar efforts on the part of US economic competitors.16
In a typical year, 1998, the US intelligence community found that some 60 “major international contracts” valued at $30 billion went to the biggest briber, according to a little noticed February 1999 speech by then Secretary of Commerce William Daley.17

As a result, mixed signals are sent out to corporations—laws exist, but are apparently not stringently enforced—and this makes it difficult for other countries that wish to follow suit in developing similar anti-bribery measures. South Africa is one such country considering what could potentially be a bold challenge to this practice of bribing foreign public officials as outlined in a draft Prevention of Corruption bill currently under discussion in the South African Parliament. If detected, a person guilty of such an offence could receive a maximum sentence of a 15-year jail term. Lack of enforcement of the FCPA and OECD Convention makes it difficult for civil society activists in South Africa to sustain pressure in ensuring that implementation is prioritised. Everybody loses, and not least the poor in the countries in which the bribes are paid.

Developing countries can contribute in ensuring that the OECD Convention is enforced. Once a foreign embassy receives information that a company based in its country is alleged to have paid a bribe, the embassy has a duty to report this to the state prosecuting authority, which is bound by law to investigate the matter. Civil society and corporate competitors in particular could be a valuable source of such information. This should be matched by political pressure from the domestic government that these cases are followed up —an indication of their commitment to clean domestic governance. This is the message which the OECD should be attempting to promote in the African media in particular, given the concern among some that corruption has reached such endemic proportions that little can be done about it. Combating bribery is not a luxury but a requirement of any government committed to ensuring the equitable distribution of resources both domestically and abroad.

The elusive foreign investor

Of the handful of cures seemingly available to the heads of ailing economies in many parts of Africa, one—which is often quoted and highly sought after but seldom seen—is the foreign investor. FDI18 has gained currency as a potential source of fixed or stable capital, which can provide the necessary capital injection to economies which are, it is argued, in need of hard currency to grow their domestic economy. The New Partnership for Africa’s Development (NEPAD) punts a capital flow initiative, which describes “private capital flows to Africa, as an essential component of a sustainable long-term approach to filling the resource gap”.

FDI may not be the only appropriate solution for domestic economic growth, particularly when it takes place at the cost of domestic labour, environmental and health standards. However, many states have limited options available to them should they wish to avoid the trappings of renewed debt cycles and conditionality.
The world’s 100 largest non-financial transnational corporation’s (TNCs) together held $1.8 trillion in foreign assets, and sold products worth $2.1 trillion abroad in 1997.19
Such TNCs are the few sources of foreign capital on offer, other than speculative capital or ‘hot money’, to developing countries. It is argued that speculative capital contributed greatly to the East Asian economic crisis in the late 1990s due to its opportunistic nature of seeking the highest returns with minimum risk exposure—particularly any attempt to tie it down to any single geographic region.

The problem faced by African countries in attracting foreign capital is perhaps exemplified in two different press releases issued by the UN Conference on Trade and Investment on the occasion of its highly regarded World Investment Report in September 2001. The good news story leads with global “foreign direct investment soars …”, a further press release of the same day leads with, “foreign direct investment in Africa shrinks…”.20 Africa counted for inflow of less than one per cent of world totals as FDI dropped from US$10.5 billion in 2000 to US$ 9.1billion in 2001.21

Perceptions of corruption and FDI

African policy makers who regard FDI as a positive engine for growth particularly in terms of new or ‘greenfield investment’ (although there are differing opinions on the matter), have set some goals to reverse these trends, as outlined in the previously quoted NEPAD document.
The first priority is to address investors’ perception of Africa as a ‘high risk’ continent, especially with regard to security of property rights, regulatory frameworks and markets. Several key elements of NEPAD will help lower these risks gradually, and include initiatives relating to peace and security, political and economic governance, infrastructure and poverty reduction.22
The first line of this policy is instructive—as South Africa’s finance minister Trevor Manuel in a separate article argues, dealing with perceptions is no small challenge.
In our country (South Africa), perceptions often rule reality. In fact they may dominate discourse to the extent that they become reality.23
Let us first turn to what informs investor perceptions with particular reference to corruption. Clearly, some of it may be the sort of negative attitudes which fuel self fulfilling prophecies. Other factors include examples, anecdotal and otherwise, which intimidate risk-weary foreign investors from the North and East who already operate under misconceptions of what it means to ‘do business in Africa’. There are many indicators that inform both fact and fantasy. Possibly one of the most often quoted is the TI Corruption Perception Index (CPI), a survey of surveys, drawing heavily on the opinions of expatriate businesspeople. With regular frequency, it ranks the world’s poorest countries (and many African countries in particular) as amongst the world’s most corrupt, and the wealthiest nations as the least corrupt of those surveyed. South African writer John Matshikiza points out:
The survey (CPI) begs the question of whether countries are born corrupt, achieve corruptness or have corruptness thrust upon them in the course of time. Equally, it does not help us to understand whether Finland (the country perceived to be least corrupt), for example, is intrinsically incorruptible or simply gained its present unblemished reputation through hard work, luck and good governance as the days went by.24
Even TI recognises the shortcoming of this approach and stresses that this country ranking is only based on perceptions which may, but do not necessarily, reflect fact.

These arguments aside, it is such surveys which are in turn often picked up by rating agencies, political risk analysts and others to contribute in defining a country’s risk profile (often together with in-house surveys). This brings us to the next point—the relative value placed on corruption as a risk factor by foreign direct investors.

In an interview conducted by the author of this paper with George S Dallas, MD of Global Emerging Markets at Standard and Poor’s, he reflected on corruption as a risk factor in the following manner:
My overarching observation is that corruption is indeed an important area of concern, and that it can play a role in impacting a country’s credit rating.25
Many of the most important political risk analysts other than Standard and Poor’s, rank corruption as one of the risk factors (among a group of approximately a dozen), which are quantified. One such example is the global consulting firm AT Kearney, which releases an FDI Confidence Index, measuring the investment attractiveness in some 25 countries. Corruption is used as one of the 20 yardsticks to measure investor confidence in these countries. In the instance of corruption, rankings are made exclusively by application of the CPI.26

Having established the fact that corruption is a determinant of risk, it is important to understand its value as a risk factor—something which is likely to inform any debate around the effects of international anti-bribery strategies on FDI inflows.

Perhaps one of the most seminal texts on the issue of corruption and FDI is by Harvard-based academic Shang-Jin Wei27 entitled, How taxing is corruption on international investors.

The papers studies the effect of corruption on FDI, using a sample that covers bilateral investment from 14 source countries to 45 host countries during 1990–91. One of the central findings made by Wei is that:
… A rise in either the tax rate on multinational firms or the corruption level in a host country reduces inward FDI. An increase in the corruption level from that of Singapore to that of Mexico is equivalent to raising the tax rate by over twenty percentage points.28
These findings are, however, based on the TI Corruption Index which is regarded as a valuable tool to raise awareness of corruption—but also one which may not reflect reality, as already discussed.

Another significant survey linking FDI and corruption is that performed by John Bray of Control Risks, which attempts to rank the effect of various risk factors on investment. The survey was conducted by the Industrial Research Bureau (IRB) on Control Risks’ behalf in September and October 1999, focusing on the international business development directors of 50 US and 71 European firms.
Respondents were asked whether they had held back from an otherwise attractive foreign investment on account of a country’s reputation for corruption, human rights, labour or environmental controversy. (Table 1)29

Table 1: Major companies deterred on account of a country's reputation for

European companies
UN companies
All
Corruption
Human rights
Environment
Labour
38%
28.%
34%
35.%
40%
13%
14%
16%
39%
27%
31%
34%
These results are revealing and magnify the importance of corruption in investor decision-making. Companies are more put off by corruption than by other key issues. A largely cynical approach would suggest that companies see profit margins threatened by corruption and not by human rights, environmental or labour abuse. However, scholars are increasingly highlighting the causal link between corruption, human rights abuse and poverty.

Research findings based on actual incidences where foreign investors decided not to invest because of corruption are hard to come by. Some anecdotal evidence, however, supports the ranking given to corruption as a decisive factor in influencing capital inflows. By way of example, Zimbabwe lost a hotel complex investment worth US$55.8 million to Zambia when Sun International chose to relocate there in 2000 citing “problems associated with red tape and demands for bribes by those in positions of authority”.30

Africa: Between anti-bribery measures and FDI

What does this all mean for African economies struggling to combat corruption and attract FDI? First, the importance of perceived levels of corruption in investor decision-making processes cannot be underestimated. Not a reason alone to combat corruption, but should countries wish to attract FDI it is worthy of serious consideration.

Having assessed some of the political risk associated with corruption it is important to consider that the international anti-bribery initiatives have two potential effects on developing economies. Although intended to combat bribery and thereby minimise the risk of corruption occurring, they at least in the initial phase when perceptions of corruption may still be high, present potential investors with an additional risk factor, namely ‘invest and you are likely to be forced to pay a bribe; pay the bribe and you could be imprisoned at home should you be caught’.

Prospective investors may be left asking in some instances if this risk is worth it. This is particularly relevant for countries which do not provide the high return of natural resources such as timber and oil. Mix in other factors such as possible political instability, drought or currency devaluation (all issues which often blight prospects for economic growth in many lesser developed economies) and investment is a near impossibility.

If stringently enforced, the OECD Convention could have the effect of making states that are on the periphery of the FDI boom (where little is perceived to be done domestically to combat corruption) even less attractive to foreign investors. Investors in the North already reluctant to commit to small economies that are perceived to be relatively corrupt, such as Malawi or Benin, may choose to stay away from these countries when confronted with the added risk of prosecution for contravening the OECD Convention.

Upping the political risk on investment may be better absorbed by states in the South with a greater capacity to ensure systemic reform needed to combat corrupt practice. This includes Southern states where the natural resources potential (or domestic market) is simply too large for multinational corporations (MNCs) to ignore, such as Nigeria, South Africa or Indonesia.

On the other hand, should the Convention not be enforced, there are even more losers at the table. Southern countries, which are attempting rigorously to implement anti-corruption strategies, will find their work undermined by MNCs willing to bribe to win tenders or purchase stakes in newly privatised enterprises. In this scenario countries like Malawi may not face an additional risk factor, but they are also not significantly better off when viewed as ‘risk prone’.

Global anti-corruption initiatives may have more than one outcome than striking the supply side of bribery. International anti-bribery initiatives—although largely progressive in the way in which they tackle graft—require careful consideration of the impact they could have if implemented independently of domestic measures designed to challenge the demand for bribes.

Conclusion

Endogenous solutions, when reached through broad consultation and developed through careful consideration of comparable experience in other countries, are likely to be the source of any effective attempts to sustain domestic anti-corruption measures.

However, instruments such as the OECD Convention have the potential, if effectively implemented, to be an important partner in this process—allowing developing countries some much needed breathing space in order to combat corruption. Given the increasing importance of international capital as both a source of graft but also as a perceived source of economic stimuli (FDI), these international initiatives are important attempts to harness capital on one hand and assist in making underdeveloped economies more attractive to foreign capital, on the other. Particularly the type of capital which seeks returns over more than just one financial year and is prepared to invest in the people of the country in which it resides.

This paper has attempted to explore some of the potential pitfalls presented if anti-corruption strategies are not co-ordinated at a domestic and international level. The real challenge is for governments to implement the often talked about domestic anti-corruption strategies, for civil society in the South to blow the whistle on corporate bribery and for authorities in the North to jail those who pay as well as the corporate directors’ who sanction the payment of bribes abroad.

Notes

  1. Kofi Annan, Global integrity in a changing world, the 9th International Anti-Corruption Conference (IACC) Durban, South Africa, 10 October 1999, <www.transparency.org> 19 May 2002.
  2. The Law of Moses 1400 Before Christian Era (BCE).
  3. The definition of corruption used for this paper is the commonly accepted ‘misuse of entrusted power for private benefit’.
  4. Globalisation, it is argued, is a process that began with the emergence of frequent inter-regional trade, perhaps more than a thousand years ago. The present model of globalisation works largely, but not exclusively, in the interest of Northern elites. The post-Seattle new social movement argues that it is not ‘anti-globalisation’, however, it takes a largely reformist, albeit at times radical, stance on globalisation.
  5. Transparency International (TI) is an international non-governmental organisation with affiliated national chapters in approximately 90 countries.
  6. Policy Paper, Corruption in the official arms trade, Transparency International–United Kingdom, 24 April 2002, <www.transparency.org.uk> 19 May 2002.
  7. “In the most recent World Development Report, the World Bank declares that across countries there is evidence that higher levels of corruption are associated with lower growth and lower levels of per capita income.” As quoted in: The worm that never dies, The Economist, London, 2 March 2002, p 11.
  8. Literally ‘politics of the belly’, a Cameroonian expression which denotes a complex mode of government that links the accumulation of wealth to political tenure, family lineage and the physical corpulence felt to be appropriate for ‘big men’ and women. J-F Bayart, S Ellis & B Hibous in The criminalisation of the state in Africa, The International African Institute in association with James Currey, Oxford, 1999, p 8.
  9. Exporting corruption—privatisation, multi-nationals bribery briefing 19, The Corner House, United Kingdom, June 2002.
  10. OECD, Convention on Combating Bribery of Foreign Public Officials in International Business Transactions. Organisation for Economic Co-operation and Development, Paris 1998.
  11. Ibid, p 4.
  12. Over 800 business leaders and senior executives in 15 of the largest emerging market economies, including South Africa, who trade with multinational firms were asked by Gallup International how likely multinational companies from 21 of the top exporting countries are to pay bribes to win or retain business.
  13. TI Press Release, Russian, Chinese, Taiwanese and South Korean companies widely seen using bribes in developing countries, Transparency International, Berlin, 14 May 2002,
  14. R Weissman, On foreign bribery, justice is out to lunch, focus on the corporation, 1998 <www.corporatepredators.org> October 2000.
  15. Ibid, The Economist, p 68.
  16. R Windrem, US spies on corruption overseas, MSNBC, New York, 21 July 2000 <www. msnbc.com>19 May 2001.
  17. Ibid.
  18. “Foreign Direct Investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (‘direct investor’) in an entity resident in an economy other than that of the investor (‘direct investment enterprise’). The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise.” OECD benchmark definition of foreign direct investment, Third Edition, OECD, Paris 1996.
  19. United Nations Conference on Trade and Development, World investment report: 1998 —trends and determinants. United Nations, New York and Geneva, 1998.
  20. Both releases available on <www.unctad.org>, 18 September 2001 (19 May 2002).
  21. Ibid.
  22. Op cit, NEPAD.
  23. T Manuel, Feelings: Nothing more than feelings, Sunday Times, 3 September 2000 <www.sundaytimes.co.za>.
  24. J Matshikiza, Why Santa is no turkey, Daily Mail and Guardian, 22 September 2000, <www.mg.co.za>.
  25. E-mail interview performed as part of post-graduate research undertaken by the author.
  26. A T Kearney, FDI Confidence Index—Global Business Policy Council, 1(3) Virginia, USA, January 2000, p 54.
  27. S Wei, How taxing is corruption on international investors, Harvard University, USA, 1998.
  28. Ibid, p 1.
  29. J Bray, Surveying Corruption, Control Risks Group, London, UK, 1999.
  30. Amid demands for bribes, kickbacks—Zim loses $30 billion project to Zambia, Zimbabwe Independent, 29 September 2000, <www.mweb.co.zw/zimin> (17 May 2002).