How Corruption Affects Emerging Economies

Economies that are afflicted by a high level of corruption—which involves the misuse of power in the form of money or authority to achieve certain goals in illegal, dishonest or unfair ways—are not capable of prospering as fully as those with a low level of corruption. Corrupted economies are just not able to function properly because corruption prevents the natural laws of the economy from functioning freely. As a result, corruption in a nation's political and economic operations causes its entire society to suffer.

According to the World Bank, the average income in countries with a high level of corruption is about a third of that of countries with a low level of corruption. Also, the infant mortality rate in such countries is about three times higher and the literacy rate is 25% lower. No country has been able to completely eliminate corruption, but studies show that the level of corruption in countries with emerging market economies is much higher than it is in developed countries. (For related reading, see: Should You Invest In Emerging Markets?)

The map below illustrates the varying levels of corruption perception in 2016 in different countries, with darker colors representing higher levels of corruption perception and lighter colors representing lower levels. Based on this map, we see the regions with developed economies—North America, Western Europe and Australia—have low levels of corruption. In contrast, a high perception of corruption is reported in almost all countries with emerging economies.

Corruption in the way deals are made, contracts are awarded, or economic operations are carried out, leads to monopolies or oligopolies in the economy. Those business owners who can use their connections or money to bribe government officials can manipulate policies and market mechanisms to ensure they are the sole provider of goods or services in the market. Monopolists, because they do not have to compete against alternative providers, tend to keep their prices high and are not compelled to improve the quality of goods or services they provide by market forces that would have been in operation if they had significant competition.

Embedded in those high prices are also the illegal costs of the corrupt transactions that were necessary to create such a monopoly. If, for example, a home construction company had to pay bribes to officials to be granted licenses for operations, these costs incurred will, of course, be reflected in artificially high housing prices. (See: Early Monopolies: Conquest and Corruption.)

In best practice, companies choose their suppliers via tender processes (requests for tender or requests for proposal), which serve as mechanisms to enable the selection of suppliers offering the best combination of price and quality. This ensures the efficient allocation of resources. In corrupted economies the companies that otherwise would not be qualified to win the tenders are often awarded projects as a result of unfair or illegal tenders (e.g. tenders that involve kickbacks). This results in excessive expenditure in the execution of projects, and substandard or failed projects, leading to overall inefficiency in the use of resources. Public procurement is perhaps most vulnerable to fraud and corruption due to the large size of financial flows involved. It’s estimated that in most countries, public procurement constitutes between 15% and 30% of gross domestic product (GDP). 

Corrupted economies are characterized by a disproportionately small middle class and significant divergence between the living standards of the upper class and lower class. Because most of the country's capital is aggregated in the hands of oligarchs or persons who back corrupted public officials, most of the created wealth also flows to these individuals. Small businesses are not widely spread and are usually discouraged because they face unfair competition and illegal pressures by large companies who are connected with government officials. (For related reading, see: Why These Industries Are Prone to Corruption.)

Because little confidence can be placed in the legal system of corrupted economies in which legal judgments can be rigged, potential innovators cannot be certain their invention will be protected by patents and not copied by those who know they can get away with it by bribing the authorities. There is thus a disincentive for innovation, and as a result emerging countries are usually the importers of technology, because such technology is not created within their own societies. (For related reading, see: Patents Are Assets, So Learn How To Value Them.)

Small businesses in corrupt countries tend to avoid having their businesses officially registered with tax authorities to avoid taxation. As a result, the income generated by many businesses exists outside the official economy, and thus are not subject to state taxation or included in the calculation of the country's GDP. Another negative of shadow businesses is they usually pay their employees lower wages than the minimum amount designated by the government and they do not provide acceptable working conditions, including appropriate health insurance benefits, for employees. (For related reading, see article: Countries With The Largest Shadow Markets.)

Corruption is one of the disincentives for foreign investment. Investors who seek a fair, competitive business environment will avoid investing in countries where there is a high level of corruption. Studies show a direct link between the level of corruption in a country and measurements of the competitiveness of its business environment. 

A working paper of the International Monetary Fund (IMF) shows corruption has an adverse impact on the quality of education and healthcare provided in countries with emerging economies. Corruption increases the cost of education in countries where bribery and connections play an important role in the recruitment and promotion of teachers. As a result, the quality of education decreases. Also, corruption in the designation of healthcare providers and recruitment of personnel, as well as the procurement of medical supplies and equipment, in emerging economies results in inadequate healthcare treatment and a substandard, or restricted, medical supply, lowering the overall quality of healthcare.

Many countries with emerging economies suffer from a high level of corruption that slows their overall development. The entire society is affected as a result of the inefficient allocation of resources, the presence of a shadow economy, and low-quality education and healthcare. Corruption thus makes these societies worse off and lowers the living standards of most of their populations.