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From Vol. 3 (4) - Autumn 2009

Corruption in Russia: A Model Exploring its Economic Costs

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Dr. Michael Barry is a professor of economics and law at Mount St. Mary’s University in Emmitsburg, Maryland, US.  He has previously served as an international economist at the US International Trade Commission, at the US Department of the Treasury, and the Ministry of Finance of the Russian Federation.  Dr. Barry has also served as consultant to the US Department of Commerce and the US Agency for International Development in various countries of Eastern Europe.

Abstract

The Russian Federation is one of 116 countries which have ratified the United Nations Convention Against Corruption, a document which sets a tone and specific provisions aimed at reducing bribery in the public and private sector, unjust enrichment of officials, embezzlement, and other forms of corruption. However, based on survey data, government reports, and the writings of international organizations, Russia has not been successful in enforcing the provisions of the UNCAC.  This paper will develop a computable general equilibrium (CGE) model to quantify the macroeconomic effects of corruption in Russia. Corruption is found to cost the Russian economy billions of dollars a year.  A conclusion of the paper is that implementing and enforcing the UNCAC would be of significant economic benefit to Russia and its people.

Keywords: Russia, corruption, computable general equilibrium, CGE, UN Convention against Corruption, UNCAC, Global Trade Analysis Project, GTAP

Executive Summary

         The Russian Federation signed the convention on December 9, 2003, and ratified it on May 6, 2006.   In total, 140 countries have signed the convention, and 116 have ratified it.  Russia had a number of reservations, but none seemed very significant.

         According to the Preamble to the Convention, the purposes of the convention are: (a) to promote and strengthen measures to prevent and combat corruption more efficiently and effectively; (b) to promote, facilitate and support international cooperation and technical assistance in the prevention of and fight against corruption, including in asset recovery; (c) to promote integrity, accountability and proper management of public affairs and public property.

         According to the UN, the major highlights of the convention include an emphasis on (a) prevention, (b) criminalization, (c) international cooperation, and (d) asset recovery. Article of the Convention enjoins each State Party to establish and promote effective practices aimed at the prevention of corruption.

         Several provisions explicitly address bribery in the public and private sector, unjust enrichment and payments, and embezzlement of property.  These provisions in particular focus on how corruption can serve as a major tax on business.  These include Articles 15, 16, 20, and 21.

         Russia has ratified the UNCAC, but enforcement is a different matter. In September 2006, Russian President Vladimir Putin declared that an inability to make much progress in the battle against corruption was one of his administration’s greatest failures.  Several organizations seem to agree that corruption in Russia decreased in the early years of Putin’s administration, but has increased again in the last two years, including Transparency International, the World Bank, Freedom House, the IMF, INDEP, Gallup, and others.

         The experiment in this CGE model is a 5 percent “corruption tax,” applied to all sectors in the Russian economy.  The “corruption tax” is added to each sector, resulting in the second column of numbers.  The goal of the GGE model will be to track the ripple effects of these tax increases through the entire Russian economy.

         According to the model, the taxing effect of corruption results in a $1.98 billion decrease in Russian GDP.  In other words, assuming a modest 5 percent burden on Russian business, corruption in Russia is costing the economy nearly $2 billion each year.

         Results suggest that corruption causes a $2.4 billion decrease in consumer welfare.  This measure is made up of three parts.  First is the allocative efficiency loss of $2.98 billion, a loss equivalent to the decrease in GDP.  The second element to welfare loss is the $3.6 billion loss in Russian terms of trade. A terms of trade loss represents a drop in global competitiveness caused by corruption.  These welfare losses are only partially offset by a $3.2 billion gain in savings and investment efficiency.

         Corruption causes both a decrease in total output as well as a significant shift of resources from some sectors to others.  Output increases in several sectors, including oil and gas (3.5 percent), metals and minerals (9.3 percent), food crops (4.0 percent), and forest and fisheries (4.3 percent).  But this is at the expense of other sectors in which production decreases, including electricity production (-0.1 percent), manufacturing (-0.3 percent), and the service industry (-2.7 percent).

         Possibly the most worrying output result is the 39.8 percent drop in the output of capital goods as the rate of return on capital in Russia decreases by 25.5 percent.  Capital goods are expenditures by businesses to increase their future production capacity: factories, research and development, equipment, infrastructure.  A decrease in this output represents both a current drop in output and, probably more importantly, a drop in future output potential.

         Corruption actually results in a $22.2 billion increase in Russia’s trade balance.  This would not be inconsistent with the large terms of trade loss Russia experiences.  Given Russia’s terms of trade, it would now take more Russian exports to finance the same number of imports.  This would explain an increase in net exports. While Russia’s net exports increase, the trade balances of its trading partners decrease, including those of the United States (-6.4 billion), the European Union (-$5.8 billion), South and East Asia (-$4.6 billion), South America (-$1.0 billion), and the rest of the world (-$3.6 billion).

         Due to corruption, Russian exports increase in every sector and Russian imports decrease in every sector, except in the electricity sector in which the opposite holds true.

         The main conclusion of this quantitative analysis is that Russians themselves would significantly benefit from closer compliance with its commitments to the UN under the Convention Against Corruption.  While all of the provisions likely have benefits, this CGE Model would emphasize the economic benefits of enforcing the general Article 5 Provisions on Prevention and provisions of Articles 15, 17, 20, and 21 against bribery in the public and private sector, unjust enrichment and payments, and embezzlement of property.
 

A.   Russia and the UN Convention Against Corruption

In its resolution 55/61 of December 4, 2000, the U.N. General Assembly decided to establish an ad hoc committee for the negotiation of such an instrument in Vienna at the headquarters of the United Nations Office on Drugs and Crime. The text of the U.N. Convention against Corruption was negotiated during seven sessions of the Ad Hoc Committee for the Negotiation of the Convention against Corruption, held between January 2002 and October 2003. This agreement was adopted by the General Assembly by resolution 58/4 in October 2003. The Convention needed 30 ratifications to come into force.  In accordance with article 68 (1) of the resolution, the United Nations Convention Against Corruption entered into force on December 14, 2005.

The Russian Federation signed the convention on December 9, 2003, and ratified it on May 6, 2006.[1]  In total, 140 countries have signed the convention, and 116 have ratified it.  Russia had a number of reservations, but none seemed very significant:

Table 1: Russian Federation Reservations to the UN Convention Against Corruption

Reservation

Content

1

The Russian Federation declares, in accordance with article 44, paragraph 6, subparagraph (a) of the Convention, that it will take the Convention as the legal basis for cooperation on extradition with other States Parties to the Convention, on a foundation of reciprocity.

2

The Russian Federation declares, on the basis of the last sentence of article 46, paragraph 13, of the Convention, that it will, on a foundation of reciprocity and in urgent circumstances, accept requests for mutual legal assistance and communications through the International Criminal Police Organization, provided that the documents containing such requests and communications are dispatched without delay in the prescribed manner.

3

The Russian Federation declares, in accordance with article 46, paragraph 14, of the Convention, that requests for mutual legal assistance and communications related thereto addressed to the Russian Federation must be accompanied by translations into Russian, unless otherwise established by an international agreement of the Russian Federation or unless otherwise arranged between the central authority of the Russian Federation and the central authority of the other State Party to the Convention.

Source: United Nations

Given these insignificant reservations, it would appear the Russian Federation was has signed on whole-heartedly to the convention (see Table 1).  Given the transition history of the former Soviet Union, Russia committed itself to major improvements in its regulation of corruption.  According to the Preamble to the Convention, the purposes of the convention are: (a) to promote and strengthen measures to prevent and combat corruption more efficiently and effectively; (b) to promote, facilitate and support international cooperation and technical assistance in the prevention of and fight against corruption, including in asset recovery; (c) to promote integrity, accountability and proper management of public affairs and public property.[2]

According to the UN, the major highlights of the convention include an emphasis on (a) prevention, (b) criminalization, (c) international cooperation, and (d) asset recovery. Article 5 of the Convention enjoins each State Party to establish and promote effective practices aimed at the prevention of corruption.  Significant provisions of Article 5 are presented in Table 2.

Table 2: UN Convention Against Corruption: Article 5 Provisions Promoting Prevention

Provision

Content

1

Each State Party shall, in accordance with the fundamental principles of its legal system, develop and implement or maintain effective, coordinated anticorruption policies that promote the participation of society and reflect the principles of the rule of law, proper management of public affairs and public property, integrity, transparency and accountability.

2

Each State Party shall endeavor to establish and promote effective practices aimed at the prevention of corruption.

3

Each State Party shall endeavor to periodically evaluate relevant legal instruments and administrative measures with a view to determining their adequacy to prevent and fight corruption.

4

States Parties shall, as appropriate and in accordance with the fundamental principles of their legal system, collaborate with each other and with relevant international and regional organizations in promoting and developing the measures referred to in this article. That collaboration may include participation in international programs and projects aimed at the prevention of corruption.

Source: Article 5 of UN Convention Against Corruption

Russia has also committed itself to criminalizing corruption. The Convention requires countries to establish criminal and other offences to cover a wide range of acts of corruption, if these are not already crimes under domestic law. In some cases, States are legally obliged to establish offences; in other cases, in order to take into account differences in domestic law, they are required to consider doing so. According to the UN Office of Drugs and Crime, the Convention goes beyond previous instruments of this kind, criminalizing not only basic forms of corruption such as bribery and the embezzlement of public funds but also trading in influence and the concealment and laundering of the proceeds of corruption.[3] Several provisions are aimed at criminalizing bribery or unjust enrichment of individuals. Table 3 presents selected provisions.

The UN Convention also commits Russia to cooperate with other signatories in every aspect of the fight against corruption, including prevention, investigation, and the prosecution of offenders. Countries are “bound by the Convention to render specific forms of mutual legal assistance in gathering and transferring evidence for use in court, to extradite offenders. Countries are also required to undertake measures which will support the tracing, freezing, seizure and confiscation of the proceeds of corruption.”[4] Finally, Russia’s ratification of the convention commits it to significant provisions on asset-recovery.  Article 51 provides for the return of assets to countries of origin as a fundamental principle of this Convention.[5] Article 43 obliges state parties to extend the widest possible cooperation to each other in the investigation and prosecution of offences defined in the Convention.[6]

Table 3: Selected Criminalization Provisions of the UN Convention Against Corruption

Article

Provision

Article 15

Bribery of national public officials

Each State Party shall adopt such legislative and other measures as may be necessary to establish as criminal offences, when committed intentionally:

(a) The promise, offering or giving, to a public official, directly or indirectly, of an undue advantage, for the official himself or herself or another person or entity, in order that the official act or refrain from acting in the exercise of his or her official duties;

(b) The solicitation or acceptance by a public official, directly or indirectly, of an undue advantage, for the official himself or herself or another person or entity, in order that the official act or refrain from acting in the exercise of his or her official duties.

Article 17

Embezzlement, misappropriation or other diversion of property by a public official

Each State Party shall adopt such legislative and other measures as may be necessary to establish as criminal offences, when committed intentionally, the embezzlement, misappropriation or other diversion by a public official for his or her benefit or for the benefit of another person or entity, of any property, public or private funds or securities or any other thing of value entrusted to the public official by virtue of his or her position.

Article 20

Illicit enrichment

Subject to its constitution and the fundamental principles of its legal system, each State Party shall consider adopting such legislative and other measures as may be necessary to establish as a criminal offence, when committed intentionally, illicit enrichment, that is, a significant increase in the assets of a public official that he or she cannot reasonably explain in relation to his or her lawful income.

Article 21

Bribery in the private sector

Each State Party shall consider adopting such legislative and other measures as may be necessary to establish as criminal offences, when committed intentionally in the course of economic, financial or commercial activities:

(a) The promise, offering or giving, directly or indirectly, of an undue advantage to any person who directs or works, in any capacity, for a private sector entity, for the person himself or herself or for another person, in order that he or she, in breach of his or her duties, act or refrain from acting;

(b) The solicitation or acceptance, directly or indirectly, of an undue advantage by any person who directs or works, in any capacity, for a private sector entity, for the person himself or herself or for another person, in order that he or she, in breach of his or her duties, act or refrain from acting.

Source: UN Convention Against Corruption

B.   Russia’s Record on Corruption

Russia has ratified the UNCAC, but enforcement is a different matter. As suggested by Robert Orttung, in September 2006, Russian President Vladimir Putin declared that an inability to make much progress in the battle against corruption was one of his administration’s greatest failures. In fact, rising corruption has been a direct consequence of Putin’s policies to strengthen the state and to crack down on many elements of Russia’s civil society.[7]  Several organizations seem to agree that corruption in Russia decreased in the early years of Putin’s administration, but has increased again in the last couple years.  These organizations include Transparency International, the World Bank, and Freedom House. While the overall number of bribes may be shrinking, the size of the bribes is growing.[8]

One study of corruption in the Russian Federation questioned 1,502 people on their views of corruption.  Forty-three percent of respondents said that corruption did not affect their families’ lives, and 29% said that it “affected it to a small degree.” But 36% of the respondents held that there was a “medium” degree of influence of corruption in the business environment, and 32% described it as “strong.” More than half the respondents (54%) said that corruption influences Russian political life “very strongly.”[9]

A Gallup Poll from Russia suggests the problem is even more widespread. In answering the question “Is corruption widespread throughout the government in your country?”, 80% of respondents gave an affirmative reply. Similarly, 79% replied affirmatively to the question “Is corruption widespread within businesses located in your country?”[10]  Only seven percent of Russians say they are satisfied with efforts to control crime and corruption in the country. In comparison, more than three times as high a percentage (23%) claim satisfaction in Italy, Turkey, and Mexico.[11] The percentages in the United States (47%), Canada (47%), and France (50%) who say they are satisfied with control of crime and corruption are about seven times as high as that in Russia.[12]

Georgiy Satarov, the president of the INDEM Fund and a leading expert on corruption in Russia, argues that the country is seeing the most voluminous blossoming of bribery in its entire history. The total sum of bribes annually meted out by Russians has reached $30 billion, Satarov claims, with the market of “everyday corruption” in which ordinary consumers pay bribes—for example, in the public health services, in the education system, on the roads, in institutions of higher learning, in Housing Management Agencies, and in child care centers—comprising about $3 billion of that.[13]

Transparency International placed Russia at 121 out of 163 countries in its Corruption Perceptions Index for 2006. Moscow has been placed 28th out of 30 in the 2005 rating of which cities are desirable places in which to do business.[14] But in 2005, A.T. Kearney placed Russia in sixth place in its rating of attractiveness for investors. Russia’s country risk ranking, according to Euromoney in March 2005, moved up to 61 out of 185 countries surveyed, while Institutional Investor for the same month placed Russia at 58 out of 173 countries.[15] In its 2006 corporate governance ratings, the World Bank placed Russia at 151 out of 208 countries, behind Zambia, Uganda, and Swaziland,[16] while its Doing Business survey put Russia at 96 out of 175 countries.[17] In the Transparency International’s Bribe Payers Index for 2006, Russia was placed 28th out of 30 countries.[18] And in the 2007 International Property Rights ranking, Russia came in at 63rd out of 70 countries.[19]

In conclusion, while Russia has signed and ratified the UN Convention Against Corruption, survey and other data suggest that Russia has yet to enforce the provisions of that convention.  The question for this paper is this: how much does a failure to enforce the UNCAC cost Russia?  Answering this question will require some assumptions and the use of a large mathematical model.


C.   A CGE Model for Corruption in Russia

This section will develop a computable general equilibrium model to quantify the macroeconomic effects of corruption in Russia and on its trading partners.  The section is broken into several parts, including, (a) a background of CGE models; (b) the Global Trade Analysis Project (GTAP); (c) the structure of this paper’s model, (d) model results; (e) model limitations and future research.

a.      Background of General Equilibrium Models

As explained by the Purdue University Global Trade Analysis Project (GTAP) website, general equilibrium, a concept which dates back to Leon Walras (1834-1910), is a pillar of modern economic thought.

“General equilibrium recognizes that there are many markets in an economy, and that these markets all interact in complex ways with each other.  In rough terms, everything depends on everything else. Demand for any one good depends on the prices of all other goods and on income. Income, in turn, depends on wages, profits, and rents, which depend on technology, factor supplies and production, the last of which, in its turn, depends on sales (i.e. demand). Prices depend on wages and profits, and vice versa.”[20]

CGE modeling techniques attempt to summarize all economic markets (supply curves and demand curves) in a large, integrated system of simultaneous equations.  All micro markets are aggregated into a macro system, which allows for discussion of economy-wide variables, such as national price level, national output, total factor productivity, sectoral output, and sectoral trade.

As in Adam Smith’s discussion of the “invisible hand,” every sectoral market must clear: supply will equal demand.  In the aggregate, “general equilibrium” occurs when supply equals demand in all individual markets (for goods, services, labor, exchange, resources, capital, and all).[21]

A CGE model is a closed system.  This means that no production or financial flow escapes the system and none are created outside of the system.  As in basic GTAP modeling, the model means that,

“We assume output will equal income.  Households, businesses, the government, the financial sector, and the foreign sector are all connected by real flows and financial flows. Intuitively, the idea of a “general” equilibrium is captured; any given market is connected to all of the other markets for the system.” [22]

b.      Structure of this Paper’s Model

The model employed in this paper is that of the GTAP project.  While the core database has 57 sectors and 66 regions, I have aggregated the matrices to simplify the world into just eight sectors, eight regions, and five factors of production.  This aggregation is described in Table 4.

The data is first, “calibrated,” meaning the model is solved for its original equilibrium prices and volumes in all markets.  This baseline is meant to represent the economy as is, before any shock takes place.  Thousands of equations are created, each representing supply and demand conditions in markets inside each region, including markets for goods, services, factors of production, savings, government expenditure, and more.  Equations are also generated for trade of all goods between each of the regions, separately created for each industry.  The calibrated result is a large set of simultaneous equations, of which the solution matches the existing prices and quantity levels of the economy.

Table 4: Aggregation used in the Model

Regions

Sectors

Factors

 

Russia

Oil and Gas

Land

 

Rest of Former USSR

Electricity

Unskilled Labor

 

United States

Metals and Minerals

Skilled Labor

 

European Union

Food Crops

Capital

 

China

Meat and Animals

Natural Resources

 

SE Asia

Forest and Fisheries

 

 

South America

Manufacturing

 

 

Rest of the World

Services

 

 

Source: Generated by Author

 

A “shock” is then introduced to system.  Mathematically, a “shock” is the alteration of a single parameter or variable in the giant system.  That change acts like a stone thrown in a pond, with waves created throughout every one of the thousands of equations in the system.  The model is re-solved with the one autonomous change, and the effects on the system are then measured.

The “shock” in this model is the introduction of a tax on business, an income tax.  In this sense, corruption is modeled as a cost of doing business (or participating in the economy).  The revenues of this tax are not accrued to the government, but to other individuals in the economy.  From a businessperson’s perspective, paying for corruption is just another cost of doing business, like a tax.

Theoretically, any tax on markets is thought to distort economic decisions and interfere with efficiency.  From the producers’ side, a tax changes relative incomes.  Producers change the amount of production, the type of production, and the method of production (inputs).  On the consumers’ side, the tax changes the relative prices of goods.  Income and substitution effects push the consumer to change the amount of his or her consumption and the choice of which goods to consume. Together these changes in production and consumption are thought to result in an efficiency loss.  More inputs are used to produce the same outputs, and the economy consumes a different mix of goods.[23]
 

c.       Model Results

The experiment in this model is a 5 percent “corruption tax,” applied to all sectors in the Russian economy.  The pre-shock tax rates of each sector are presented in the first column of Table 5.  The “corruption tax” is added to each sector, resulting in the second column of numbers.  The goal of the GGE model will be to trade the ripple effects of these tax increases through the entire Russian economy.    

Table 5: Russian Output tax by Sector (Percent)

 

Initial

With Shock

RTO

rTO

rTO

1 Land

6.8

11.8

2 UnSkLab

21.5

26.5

3 SkLab

21.5

26.5

4 Capital

6.8

11.8

5 Nat. Resources

6.8

11.8

6 Oil & Gas

18.7

23.7

7 Electricity

2.8

7.8

8 Metals & Min.

3.3

8.3

9 Food Crops

1.5

6.5

10 Meat Animals

-0.5

4.5

11 Forest & Fish

2.9

7.9

12 Mnfcs

2.5

7.5

13 Services

2.6

7.6

14 CGDS

0

5

Source: Generated by Author

Gross Domestic Product (GDP) is a measure of the final value of all production of goods and services within the borders of the Russian Federation.  As shown in Table 6, according to the model, the taxing effect of corruption results in a $1.98 billion decrease in Russian GDP.  In other words, assuming a modest 5 percent burden on Russian business, corruption in Russia is costing the economy nearly $2 billion each year.

Table 6: Change in Russian GDP
(Millions of Dollars)

Qgdp

(Sim)

Pre 

Post 

Change

Russia

-0.64

309,948

307,963

-1,984.9

Rest of USSR

-0.03

104,328

104,296

-32.6

USA

0

10,082,155

10,082,199

44.0

EU

0.01

7,929,525

7,930,110

585.0

China

0

1,321,825

1,321,828

3.5

SEAsia

0

5,531,997

5,532,130

133.5

SAmerica

0.01

1,345,630

1,345,704

74.0

ROW

0.01

4,653,195

4,653,461

266.0

Source: Generated by Author

While GDP measures the amount of production in the Russian economy, a slightly different question is what effect corruption has on consumer welfare—the utility consumers in Russia enjoy from consuming goods.  As shown in Table 7, according to the model, corruption causes a $2.4 billion decrease in consumer welfare.  This measure is made up of three parts.  First is the allocative efficiency loss of $2.98 billion.  This loss is equivalent to the decrease in GDP and represents a loss in efficiency—that the same inputs produce less output in the presence of corruption.  The second element to welfare loss is the $3.6 billion loss in Russian terms of trade. A terms of trade loss represents a drop in global competitiveness caused by corruption.  A country exports goods in order to earn foreign exchange needed to purchase imports.  With corruption, Russia will receive fewer imports in exchange for its exports.

These welfare losses are partially offset by a gain in savings and investment efficiency.  While corruption and rent-seeking is a distorting cost of doing business, there are individuals who are the recipients of the bribes and payoffs.  These individuals have a source of extra funds now—available for savings, investment, or more consumption.  This welfare gain, however, is not enough to make up for the loss in allocative efficiency and terms of trade.  The total effect of corruption, according the model, remains a negative $2.4 billion.

Table 7: Welfare Effects
(Millions of Dollars)

WELFARE

Allocative Efficiency

Endowments

Technology

Population

Terms of Trade

Savings and Investment

Total

1 Russia

-1,984.9

0.0

0.0

0.0

-3,570.6

3,165.5

-2,389.9

2RestofUSSR

-32.6

0.0

0.0

0.0

68.6

-8.2

27.8

3 USA

44.4

0.0

0.0

0.0

1,524.5

-100.3

1,468.6

4 EU

584.8

0.0

0.0

0.0

1,793.6

-759.3

1,619.0

5 China

3.5

0.0

0.0

0.0

345.6

-529.5

-180.5

6 SEAsia

133.6

0.0

0.0

0.0

1,642.0

-1,116.7

658.9

7 SAmerica

74.0

0.0

0.0

0.0

-70.2

-91.5

-87.7

8 ROW

266.0

0.0

0.0

0.0

-1,733.4

-559.9

-2,027.3

Total

-911.1

0.0

0.0

0.0

0.0

0.0

-911.1

Source: Generated by Author

These losses can be traced to individual sectors of the Russian economy.  As shown in Table 8, the corruption tax causes both a decrease in total output, as well as a significant shift of resources from some sectors to others.  Output increases in several sectors, including oil and gas (3.5 percent), metals and minerals (9.3 percent), food crops (4.0 percent), and forest and fisheries (4.3 percent).  But this is at the expense of other sectors in which production decreases, including electricity production (-0.1 percent), manufacturing (-0.3 percent), and the service industry (-2.7 percent).

Possibly the most worrying output result, however, is the 39.8 percent drop in the output of capital goods.  While the GTAP model is not well equipped to analyze dynamic changes in investment and future incomes, this decrease in capital good production is significant.  Capital goods are expenditures by businesses to increase their future production capacity: factories, research and development, equipment, infrastructure.  A decrease in this output represents both a current drop in output and, probably more importantly, a drop in future output potential.  Even without corruption, the Russian Federation would be suffering from extremely low levels of business investment.  That corruption would so strongly impact what little investment already takes place is striking. Corruption is hurting the present and the future of Russia.

Table 8: Change in Output, by sector (Percent)

Qo

Russia

Rest
of USSR

USA

EU

China

SEAsia

SAmerica

ROW

Oil & Gas

3.5

-0.72

-0.57

-0.66

-0.52

-0.63

-0.6

-0.63

Electricity

-0.14

0.14

-0.02

0

-0.02

-0.03

-0.02

0.03

Metals & Min.

9.31

0.01

-0.16

-0.17

-0.09

-0.25

-0.16

-0.15

Food & Crops

4.09

-0.21

-0.04

-0.05

-0.01

-0.05

-0.08

-0.05

MeatAnimals

1.83

-0.1

-0.05

-0.1

0.01

-0.02

-0.06

-0.03

Forest & Fish

4.31

-0.04

-0.08

-0.09

-0.08

-0.11

-0.03

-0.02

Mnfcs

-0.26

-0.04

-0.04

0

0.01

-0.08

0.16

0.29

Services

-2.73

0.13

0.02

0.02

0.03

0.04

0.02

-0.01

CGDS

-39.8

0.74

0.31

0.38

0.2

0.38

0.38

0.36

Source: Generated by Author

The significant drop in production of capital goods is caused by a significant decrease in returns on business investment.  As shown in Table 9, the rate of return on capital in Russia decreases by 25.5 percent.[24]  Businesses and individuals in Russia see a much weaker incentive to take risks on innovation, invention, entrepreneurship, and investment.  Apparently, a corruption tax disproportionately falls on capital good output.  Again, this is a serious drag on economic growth for the Russian Federation.

Table 9: Rate of Return on Capital (Percent Change)

Rorc

(Sim)

Russia

-25.47

Rest of USSR

0.35

USA

0.06

EU

0.06

China

0.06

SEAsia

0.07

SAmerica

0.07

ROW

0.07

Source: Generated by Author

These results are consistent with economic literature.  According to the International Monetary Fund (IMF), corruption may reduce investment by adding to its cost and by acting as a tax on its returns, and by adding to uncertainty. According to John Roaf of the IMF, high levels of corruption are likely to have been an especially important factor behind Russia’s extremely low level of foreign direct investment for several reasons: (i) the relatively large size of foreign investments, and the special regulations applying to them, are particularly conducive to rent-seeking; (ii) local companies may use corruption to shut foreign competitors out; and (iii) foreigners lack specific knowledge of how to operate in a particular corrupt environment.[25]

From a Russian consumer’s perspective, corruption leads results in decreased consumption.  As shown in Table 10, according to the CGE model, a 5 percent “corruption tax” results in a 7.2 percent decrease in Russian private consumption. Corruption leads to lower personal income, and thus less consumption.  It also changes relative prices, producing substitution effects as consumers try to change their consumption away from more expensive goods and towards cheaper ones.

Table 10: Private Consumption
(Percent Change)

Yp

(Sim)

Russia

-7.15

Rest of USSR

-0.35

USA

0.19

EU

0.14

China

0.13

SEAsia

0.21

SAmerica

0.13

ROW

0.06

Source: Generated by Author

In addition to internal economic impacts, corruption appears to significantly affect Russia’s trade with other countries of the world.  As shown in Table 11, according to the CGE model, this five percent “corruption tax” actually results in a $22.2 billion increase in Russia’s trade balance.  This would not be inconsistent with the large terms of trade loss Russia experiences.  Given Russia’s terms of trade, it would now take more Russian exports to finance the same number of imports.  This would explain an increase in net exports. While Russia’s net exports increase, the trade balances of its trading partners decrease, including those of the United States (-6.4 billion), the European Union (-$5.8 billion), South and East Asia (-$4.6 billion), South America (-$1.0 billion), and the rest of the world (-$3.6 billion).

Table 11: Change in Trade Balances (Millions of Dollars)

DTBAL

(Sim)

Russia

22,224.9

Rest of USSR

-168.0

USA

-6,388.6

EU

-5,830.2

China

-726.4

SEAsia

-4,572.2

SAmerica

-968.5

ROW

-3,571.0

Source: Generated by Author

The change in trade balances can be broken down by sector, as presented in Table 12.  For Russia, it sees an improved trade balance in every single sector except electricity.  Russian services experience the greatest trade balance improvement ($7.1 billion), mostly at the expense of services in the EU (-$2.6 billion), the United States (-$1.7 billion), and South and East Asia (-$1.2 billion). Similarly, Russia’s trade balance in manufactured goods improves by $6.9 billion, mostly at the expense of the U.S. manufacturing trade balance (-$4.0 billion) and that of the EU (-$1.8 billion).  Other major shifts occur in the trade balances of oil and gas, and that in metals and minerals.

Table 12: Change in Trade Balances by Sector (Millions of Dollars)

DTBALi

Russia

Rest
of USSR

USA

EU

China

SEAsia

SAmerica

ROW

Oil & Gas

2513.74

-27.28

560.3

733.17

-23.77

489.11

-430.79

-3843.45

Electricity

-61.03

45.61

-9.54

3.21

-0.3

-0.41

-3.61

26.07

Metals & Min

3839.22

23.32

-753.25

-1100.17

-253.82

-790.49

-177.43

-810.39

Food & Crops

1685.77

-167.49

-315.66

-376.29

-56.63

-316.55

-156.49

-231.74

Meat & animals

96.7

-11.93

-8.32

-36.72

-12.36

-9.87

-1.35

-17.1

Forest & Fish

180.51

-0.4

-13.62

-40.24

-24.77

-33.7

-2.2

-60.45

Mnfcs

6864.89

-136.57

-4048.72

-2459.41

-114.6

-2669.8

79.98

2380.14

Services

7105.06

106.72

-1799.79

-2553.7

-240.16

-1240.46

-276.65

-1014.06

Source: Generated by Author

Exports and imports are examined individually in Table 13 and Table 14.  In general, Russian exports increase in every sector and Russian imports decrease in every sector, except in the electricity sector.  Sectors with the highest percent increase of exports in Russia include services (25.8 percent), meat and animals (23.6 percent), food crops (17.8 percent), and metals and minerals (15.0 percent). Sectors with the largest percent decrease in Russian imports include services (-23.1 percent), meat and animals (-22.1 percent), manufacturers (-10.8 percent), and forest and fisheries (-7.4 percent).

Table 13: Value of Exports by Sector (Percent Change)

 

Vxwfob

Russia

Rest
of USSR

USA

EU

China

SEAsia

SAmerica

ROW

 

Oil & Gas

6.63

-2.04

-4.91

-2.12

-4.31

-2.48

-2.64

-1.93

 

Electricity

-7.24

2.43

-0.44

0.11

0.08

-0.01

-0.01

0.28

 

Metals & Min.

14.95

0.75

-0.74

-0.36

-0.32

-0.62

-0.37

-0.27

 

Food & Crops

17.75

-2.83

-0.3

-0.09

-0.1

-0.16

-0.24

-0.1

 

Meat & Animals

23.63

-3.47

-0.11

-0.37

-0.31

-0.13

-0.1

-0.12

 

Forest & Fish

10.51

0

-0.75

-0.61

-0.79

-0.85

-0.3

-0.81

 

Mnfcs

9.53

-1.39

-0.2

0

0.09

-0.13

0.36

0.47

 

Svces

25.81

0.53

-0.51

-0.26

-0.12

-0.32

-0.39

-0.25

 

Source: Generated by Author

 

 

Table 14: Value of Imports by Sector (Percent Change)

Viwcif

Russia

Rest of USSR

USA

EU

China

SEAsia

SAmerica

ROW

OilGas

-6.3

-1.18

-0.8

-1.14

-0.1

-1.15

-1.03

0.21

Electricity

4.65

-1.23

0.39

0.06

0.14

0.25

0.15

0.01

MetalsMin

-5.38

1.37

0.43

0.14

0.42

0.32

0.25

0.29

FoodCrops

-9.6

0.74

0.3

0.12

0.23

0.31

0.14

0.12

MeatAnimals

-22.12

2.87

0.32

0.23

0.22

0.25

0.17

0.3

ForestFish

-7.41

1.59

0.14

0.17

0.85

0.25

0.17

0.38

Mnfcs

-10.8

-0.34

0.32

0.17

0.15

0.22

0.15

0.12

Svces

-23.13

-0.66

0.34

0.19

0.18

0.34

0.26

0.16

Source: Generated by Author

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


d.      Model Limitations and Future Research

This experiment raises several methodological questions.  First, the magnitude and character of corruption costs to businesses are worth exploring.  While this model imposes an empirically-supported “corruption tax” on businesses (as provided from survey data), the five percent tax on business is assumed to be the same across sectors.  It would be reasonable to assume corruption is stronger in some sectors and weaker in others, so a better experiment would be one which allowed for these sectoral differences.

Second, this model is a static model.  It does not capture the changes in capital infrastructure and production capacity over time.  While the current effect on capital goods output is apparent, the long-term effect of that drop in production capacity is not modeled here.  It would surely increase the final cost of corruption to society, as measured by a model.

Finally, while this experiment quantifies economic impacts of corruption, the causal relationship between anti-corruption laws and lower corruption remains an assumption of the model.  A conclusion of the paper is that Russia should increase its laws and regulations in the battle against corruption, but exactly how much that campaign would change the numbers in this study is not clear.                      


D.   Conclusion and Policy Implications

The main conclusion of this quantitative analysis is that Russians themselves would significantly benefit from closer compliance with its commitments to the UN under the Convention Against Corruption.  While all of the provisions likely have benefits, this CGE Model would emphasize the economic benefits of enforcing the general Article 5 Provisions on Prevention and provisions of Articles 15, 17, 20, and 21 against bribery in the public and private sector, unjust enrichment and payments, and embezzlement of property.  These provisions in particular focus on how corruption can serve as a major tax on business.  As with any tax, this “corruption tax” distorts markets and causes change in producer and consumer behavior.  The net result is a welfare loss to the Russia economy.

According to Ortung of the CSIS, four components would define an effective anti-corruption policy in Russia.[26] The first would be to reduce and reform the current bureaucracy.[27] The second would be to allow society to hold its government accountable through mechanisms such as a free press, an active and independent civil society, and competitive elections.[28] A third feature of an anti-corruption policy would be the decentralization of power from the federal level to regional and local levels, providing for a system of checks and balances between the three levels of government.[29] Finally, Russia should try to address inequality between Moscow and St. Petersburg and the rest of the country.[30]

Along the same lines, economists from the IMF suggest measures which would reduce opportunities for corruption by eliminating discretionary elements of government policy. In particular, a more transparent and well-administered tax-collection system would reduce bribery and official corruption.[31]  Equally important is government regulation and licensing of economic activity. According to the IMF, the average new business applicant must deal with 20-30 registration and licensing agencies. Simply cataloguing all the regulations applying to business would be useful in helping expose which regulations are economically justifiable and which exist mainly to extort rents.[32]

The list of suggestions goes on and on, and the problems of corruption seem well appreciated.  The contribution of this paper has been to quantify the impact of these problems.  And in a general way, it emphasized the importance of adhering to a philosophy that corruption is detrimental to an economy.  Whether it is the UN Convention Against Corruption, an agreement with the OECD, an internal campaign to reduce corruption, or a change in the behavior of Russian citizens themselves, the message is clear: Corruption comes at a cost. Russia should comply with the UNCAC.


 

[1] United Nations Office on Drugs and Crime, “UN Convention Against Corruption,” U.N. Office on Drugs and Crime, http://www.unodc.org/unodc/en/treaties/CAC/signatories.html (accessed April 12, 2008).

[2] United Nations, “Chapter I, Article 1 of the UN Convention Against Corruption,” United Nations Office of Drugs and Crime, http://www.unodc.org/pdf/crime/convention_corruption/signing/Convention-e.pdf (accessed April 16, 2008).

[3] Id.

[4] Id.

[5] United Nations, “Chapter V, Article 51 of the UN Convention Against Corruption,” United Nations Office on Drugs and Crime, http://www.unodc.org/pdf/crime/convention_corruption/signing/Convention-e.pdf (Accessed April 16, 2008).

[6] Id., Chapter IV, Article 43.

[7] Robert Orttung, “Causes and Consequences of Corruption in Putin’s Russia,” PONARS Policy Memo No. 430, Center for Strategic and International Studies, (Washington D.C.), December 2006.

[8] Id.

[9] Elena Panfilova, “Corruption Levels in the Russian Federation: Research Data for 2006,” (working paper for Center for Anti-Corruption Research and Initiatives, Transparency International-Russia, November 2006).

[10] Sergei Gradirovski and Neli Esipova, “Corruption in Russia: Greasing the Wheels to Get By,” Gallup News Service, http://www.gallup.com/poll/25435/Corruption-Russia-Greasing-Wheels-Get.aspx (accessed November 14, 2006).

[11] Id.

[12] Id.

[13] See Information Science for Democracy (INDEM), Diagnostics of Corruption in Russia 2001-05. Available at: http://www.indem.ru/en/index.shtml.

[14] Novye izvestia, “Business Today,” October 10, 2005.

[15] BOFIT Weekly. “Russia,” April 15, 2005.

[16] Moscow Times, “Corruption Issues,” September 18, 2006.

[17] BOFIT Weekly, “Russia,” September 15, 2006.

[18] Id.

[19] Id.

[20] T. Hertel, R. Keeney, M. Ivanic and Alan Winters, “Distributional effects of WTO agricultural reforms in rich and poor countries,” Economic Policy, (April 2007): 289-337.

[21] Id.

[22] T. Hertel, R. Keeney, M. Ivanic and Alan Winters, “Distributional effects of WTO agricultural reforms in rich and poor countries,” Economic Policy, (April 2007): 289-337.

[23] For more on economic efficiency and taxation, see Campbell R. McConnell and Stanley L. Brue, Economics: Principles, Problems, and Policies (McGraw Hill Publishing, 2006).

[24] This does not represent a 25.5 percentage-point drop in the interest rate or yield on investment.  Rather, it represents a 25.5 percent decrease in the yield itself.  For example, if the rate of return had been 10 percent, a 25 percent drop would leave the rate of return at 7.5 percent. Either way, the decrease is still very large.

[25] James Roaf, “Corruption in Russia,” International Monetary Fund, European II Department, Conference on Post-Election Strategy, Moscow, April 5-7, 2000.

[26] Robert Orttung, “Causes and Consequences of Corruption in Putin’s Russia,” PONARS Policy Memo No. 430, Center for Strategic and International Studies, December 2006.

[27] Id.

[28] Id.

[29] Id.

[30] Id.

[31] James Roaf, “Corruption in Russia,” International Monetary Fund, European II Department, Conference on Post-Election Strategy, Moscow, April 5-7, 2000.

[32] Id.

       
 
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