Part One

The more laws are decreed, the more we’ll become thieves and bandits\'. Lao-tse (4th or 3rd century BC).

The above quote illustrates that corruption – the abuse of political power for private gain – has been a bane of ordinary people in East and West since time immemorial. There was a tradition of fatalistic acceptance that greasing the palms of officials is necessary to grease the wheels of government. A little graft was considered an expression of good will towards underpaid officials or a legitimate form of competition. Resignation about corruption was accepted by most religions. It is for example mirrored in many passages of the Talmud and the Bible, beginning with Genesis (IV, 2): \"God looked upon the earth and, behold, it was corrupt; for all flesh had corrupted his way upon the earth.\"

Nowadays, corruption is increasingly seen as an affront to the notion that all men are born equal to pursue their happiness with all the means they can legitimately marshal. This individualistic notion gained popular acceptance originally in the West during the Enlightenment. It had consequences for the roles of citizens and rulers. These were, for example, spelled out with great clarity in the pioneering 1776 Pennsylvania Declaration of Rights: \"All power being derived from the people: therefore all officers of government, whether legislative or executive, are the trustees and servants and in all times accountable to them\".  In other words, the citizens are the principals and the officials no more than their agents, who are expected to act honestly. Since the Second World War, this democratic spirit has been spreading around the globe – albeit often as an aspiration, rather than a reality. 

The philosophers of the 18th century, such as Adam Smith, fought a major struggle of their time when they characterized corruption as morally wrong. Their teachings are now spreading around the world and underpin a new optimism that graft can be cleaned up. The Organization of Economic Cooperation and Development (OECD) and the World Bank have urged member governments to make bribe paying to foreign officials and firms a criminal offence. Exporters from OECD countries have sometimes argued that this puts them at a competitive disadvantage vis à vis corrupt local competitors, but some OECD governments have nevertheless made corrupt dealings by their nationals a punishable offence. They have done so because they recognized that corruption creates unjust privileges for well-connected elites in government and industry, and unjustly disadvantages all other citizens. Corruption is also an obstacle to genuine competition by price and quality, and hence to economic growth.

Those who tolerate or even promote corruption debase the institutions, which are an essential condition for economic growth. They perpetuate poverty, injustice and misery. Competitors, who rely on corruption to promote their business, betray the fundamental conditions of the market economy, for the modern division of labour depends on the exploitation of what people know, and not on who offers the biggest bribes. Wealth creation is based on technical and commercial knowledge and its effective communication through market signals that guide effective specialization and innovation. For this to happen, markets have to be based on trust among strangers. Corruption poisons this foundation. It invites decisions to be made on the basis of who one knows and not what is known to be best. Corruption in business also invites costly regulations, which make the market signals less efficient.

The development experience over the past half-century shows that poor economic growth is not the consequence of lack of natural resources, capital or other resources. All economies that have failed to grow have in common poor rules of coordination of social and economic life – institutions – standing in the way of saving, investment, resource exploration and other entrepreneurial efforts to mobilize productive forces. The doyen of development economics, the late Lord Peter Bauer, said it clearly: \"Economic performance depends on personal, cultural, and political factors, on people\'s aptitudes, attitudes, motivations, and social and political institutions....” The institutions matter so much because the growth process requires the coordination of many people with special knowledge, who incur transaction costs and take risks to explore new and better ways of doing things. One hardly has to add that economic growth has wiped out many traditional ills which have long plagued humanity: high child mortality, arduous toil, recurrent hunger, disease, grime, ignorance, perpetual discomfort and boredom, early aging and short life spans.

What matters for economic growth is not only the quality of the institutions, but also how effectively and even-handedly they are applied and enforced. Some rules are enforced within societies: Cheaters are, for example, shunned spontaneously and lose their reputation, liars are reprimanded, and so on. Other rules are designed and enforced by political action from above: Governments legislate to protect life and private property; they organize a judicial system and a police to enforce these rules. Activities, which cause harm to others, are made subject to government licenses; and so on. In the case of such political rules, societies empower agents of government – for example the judiciary, administrators, and the police – to enforce the rules. These agents are given monopoly powers of legitimate coercion, and it is essential for justice and prosperity that these powers are applied without fear or favour, and without the agents of government exploiting them to their own private advantage.

Communities, in which coordination is achieved mostly by rules internal to society and by spontaneous enforcement and therefore with limited reliance on the external rules of government, tend to operate more effectively in attaining economic growth and equal opportunity than communities that are governed by a heavy hand and subjected to numerous prescriptive rules. This is so precisely because the agents of government often yield to the common human temptation of self-seeking opportunism and act corruptly. After all, the agents of government are always able to exploit the public\'s lack of knowledge of all the details and circumstances of particular matters to promote their own interests at the expense of the general public (corruption).

Once entrenched, corruption has pervasive effects and perpetuates itself. One example is the open or secret sale of commissions and positions, such as jobs for schoolteachers and policemen. I have seen first hand in Indonesia how parents have to buy jobs for their educated sons and daughters, often at a considerable financial sacrifice. Once the job is acquired, it \'belongs\' to the successful candidate who then does not need to retain it by ongoing performance. In addition, the \'investment\' has to be retrieved by the family through selling preferential treatment or collecting \'dues\', which are a return on the investment in the job. Calls for promotion by exam and merit are then perceived as moves to deprive officials of rightful returns on their past \'investments\'. Such reforms cannot be enforced from the outside; they can only be tackled by local reformers.

It is a well-established fact that the incidence of official corruption correlates with economic freedom, this is how reliably the institutions secure private property rights and the freedom of their use and how impartial and reliable the country\'s rule of law is.  Heavy and detailed regulation, which affects private incomes and wealth all the time, is a precondition for pervasive graft. Indeed, one cannot resist the conclusion that some regulations are put in place predominantly to enable people in power to extract bribes. Economics Nobel laureate Amartya Sen, who correctly perceives the economic development of poor countries as liberation, has argued that unilateral deregulation in developing countries is justified by the collateral reduction of corruption, irrespective of whether it confers other benefits. Honest government also contributes to trust among the people.

The central role of institutions for economic growth, which was understood by Adam Smith, was not understood for a long time during the 20th century, neither by theorists nor in policy making. Austrian institutional economists, such as Peter Bauer, were in a small minority. But since the 1980s, the evolutionary-institutional approach has gained ground and has had the major influence on policy making and reform. Recently, even some international organizations have begun to pay serious attention to institutions and their honest application. Thus, the 2005 issue of the International Monetary Fund\'s World Economic Outlook focuses on \"Building Institutions\" (chapter 3) and states: \"Higher growth depends on ... stronger property rights, lower corruption, and better governance\". This should have important consequences for their policies, for example how foreign aid is transferred to countries with poor institutions.

One fundamental point bears reiterating: Differences in public attitudes to corruption and economic freedom spring from a fundamental dichotomy of worldviews. The modern Western view, which holds individuals to be the principals and their interests as pre-dominant in the business of governance, contrasts with the view of political elites in most traditional and non-Western societies. They consider themselves as the principals and \"their\" people as a resource to be exploited to promote their power and wealth. Globalization now spreads the individualist worldview. People around the world now attack the selfish interests of the powerful elites as corruption and their voice can be less and less suppressed.