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February 1, 2013

Developmental Corruption in China

Charles Wolf Jr. on Double Paradox: Rapid Growth and Rising Corruption in China by Andrew Wedeman

Economists occasionally feel called upon to correct, or at least modify, conclusions reached by political scientists, sociologists, or other members of the putatively “softer” social sciences. Examples of this hubristic role abound. For instance, the conventional wisdom among social scientists in bygone days was that “pay-as-you-go” Social Security would encourage household savings — economists correctly predicted the opposite effect. Aid to Families with Dependent Children was enacted with the conventional expectation that this entitlement would promote stability in poor families — instead, it had the opposite effect, in accord with what economic theory would predict. Also, several decades ago when the Soviet Union sought to expand its imperial reach by spreading largesse around the world, foreign policy wonks worried about the fearful consequences of this effort — economists provided empirical evidence that, instead, the effort was costing the Soviets more than it was worth.

Andrew Wedeman, a political scientist at the University of Nebraska, has accomplished a reversal of this pattern. His Double Paradox is a carefully reasoned and empirically grounded analysis of corruption in China, which runs counter to prior, frequently-cited work by economists. The initial motivation, he tells us, for his long immersion in the subject of corruption sprang from economists’ work in the mid-1990s which indicated that corruption exacted a measurable cost in forgone economic growth — in other words, corruption hindered growth. Instead, Wedeman’s own substantial experience in China was, to the contrary, that corruption and growth thrived together: Corruption worsened as growth prospered. The economists were evidently missing something. The book’s title (including its subtitle: “Rapid Growth and Rising Corruption”) reflects Wedeman’s efforts to resolve this puzzle.

Wedeman defines corruption simply as “the improper use of public authority for private gain or advantage,” and the book’s title represents his “attempt to reconcile the double paradox of rapid growth and intensifying corruption.”

To keep matters in balance, it’s worth pointing out that his attempted reconciliation doesn’t exactly refute the prior economic work that motivated his study. That prior work — a rigorous, cross-sectional, and time-series analysis by economist Paolo Mauro — found a statistically significant negative relationship between corruption (measured in several different ways) and aggregate investment as a fraction of gdp. Measured across time and across countries, higher levels of corruption were correlated with significantly lower rates of investment. However, the direct relationship between corruption and economic growth (as distinct from the relation between corruption and investment) was, according to this prior work, not statistically significant.

While the investment rate surely affects growth (so, if higher corruption lowers investment, growth might be expected to suffer as well), growth and investment are not equivalent. Indeed, later studies suggest that other things — for example, technology, innovation, entrepreneurship, and human capital (as distinct from physical investment) — are at least as important as the investment rate in affecting economic growth. If, for example, in post-Maoist, reformist China corruption actually facilitated innovation and entrepreneurship (elements of human capital that were impermissible and indeed prosecutable during Mao’s Cultural Revolution of the 1960s), the expected result might well be higher growth notwithstanding a lower investment rate. Hence, Wedeman’s reconciliation between corruption and growth is not fully dispositive of the prior work that motivated his own, although he assuredly registers on the other side of that divide.

The first third of Double Paradox deals with the generic distinction between “developmental corruption” and “degenerative corruption.” Developmental corruption, according to Wedeman and exemplified by his case studies of Japan, Korea, and Taiwan, evolved as a coalition between a politically dominant entity, on the one hand (in Japan, the Liberal Democratic Party; in Korea’s erstwhile days, the military; in Taiwan, the Kuomintang), and pro-growth business interests, on the other. Sustaining these coalitions in these three countries was an implicit — and sometimes explicit — understanding that the politically dominant group would implement pro-growth policies sought by business, and these emergent business interests would compensate the politicians with ample funding to support and continue their dominance of government. Development and corruption prospered together.

The result of this “developmental corruption” was a protracted period of both political stability and sustained economic growth in the three countries, including the lengthy tenure of the politically favored ally in each country — until recent years. The political machines in these countries became in effect development machines; hence, they were the vehicles of developmental corruption.

By way of contrast, degenerative corruption (alternatively termed predatory corruption, or simply kleptocracy), extracts a toll, typically a large and increasing one, irrespective of whether the economy is growing, stagnant, or impoverished, and without regard for enacting policies to promote economic growth or to avoid policies that would hinder it. For this type of corruption, think of plunder, piracy, extortion, or Chicago gangsterism. Double Paradox includes vignettes of degenerative corruption exemplified by Zaire, Haiti, the Dominican Republic, Sierra Leone, the Central African Republic, and, perhaps the most egregious of all, Equatorial Guinea.

The book then shifts to concentrate on corruption in China, with exhaustive details of the similarities and differences between China and the other cases covered in the previous chapters. This part of the book is an exposition, as the familiar phrase might put it, of corruption with Chinese characteristics.

China didn’t have to develop a political machine to propel growth from the top down (as in Japan, Korea, and Taiwan) because it already had a formidable one in the Communist Party. In the post-Mao era, propelling growth was at the top of the party’s agenda from the inception of Deng Xiaoping’s reforms in the late 1970s and continuing into the present. At the start of this reformist era, corruption was only sporadic and decentralized; it was not “entrenched,” according to Wedeman. Reforming the planned economy in the direction of a more market-based system provided the incentives and drivers for accelerating growth, as well as opening up abundant opportunities for new and lucrative forms of corruption.

At the core of the ensuing corruption, according to Wedeman’s account, was the “dual-track price system”: that is, the transition away from prices prescribed by the planned economy and toward prices increasingly determined by competitive markets. This reformist process affected prices of commodities, investments, land, construction, and notably the prices at which government assets were sold by officialdom (including, of course, members of the Communist Party’s hierarchy) to market-based buyers. These buyers included both private, commercial businesses and state-owned enterprises, which themselves experienced varying degrees of privatization through equity sales to private, nongovernment buyers.

In all of these transactions, arbitraging between the lower controlled prices and the higher market prices afforded lucrative opportunities for rent-seeking behavior by the participants. One might add that this process foreshadowed a similar one in the 1990s in Russia, when assets of the defunct Soviet Union were auctioned to preferred buyers at preferred prices, giving rise to Russia’s notorious “oligarchs.”

In China, the ensuing corruption was contemporaneous with dramatic economic growth that, like the corruption, was also generated by reform toward a more market-based economy. Therein is the essence of Wedeman’s resolution of the double paradox: The same reformist process that engendered rapid growth via the market mechanism was also the root source of rising corruption (hence, the book’s subtitle). Marketized reform was the engine propelling both growth and corruption.

Wedeman’s successful demonstration of the compatibility between rapid growth and rising corruption is not, however, the same as saying that the interactions between the two are equivalent in both directions. Rapid growth through transition to a more marketized economy enlarges the fare on which corruption can feed. Furthermore, even if the effect of this were to reduce the effective rate of investment (recall the prior reference to Paolo Mauro’s work on corruption and investment), or to lower the productivity of investment, a relatively high rate of economic growth might persist, and indeed continued to do so. Such has been China’s record thus far. Whether it will endure remains to be seen.

Wedeman next focuses on the measurement of corruption, and of China’s anti-corruption efforts. His attempts at quantifying corruption are original and informative, if only partly successful. In the process he introduces such concepts as the “revealed rate of corruption” (rrc), consisting of the number and gravity of corrupt deeds that are detected and prosecuted; the “actual rate of corruption” (arc) which, in principle, is the full extent of corruption (the iceberg of which rrc is the top); and the gap between the two, which he presumes to be dependent on “the intensity of enforcement.” While the arc and the gap between it and the rrc are unobservable, Wedeman avers that variations in them can be inferred from the time periods “when the authorities launched anti-corruption campaigns.” These periods are well-known because they’ve periodically been highly publicized. Cleverly, if not entirely convincingly, he then uses the ratio between rrc and arc during the relatively high-intensity enforcement periods to help in estimating the “emerging rate of corruption” (erc) and the “cumulative level of corruption” (clc).

Most readers are as likely to be put off as to be engaged by the somewhat contrived character of these constructs. Nevertheless, the use he makes of them is of interest. Partly through their use, partly without it, Wedeman presents data from 1980 through 2008 on a range of corruption indicators including the numbers of cases of economic crimes detected and prosecuted; the levels and numbers of officials involved in corruption cases; and the financial scale of these cases. The takeaway from his analysis of these indicators is that although “the surge [in corruption] began after the advent of reform, it was not until the early 1990s that high-level corruption began to intensify.”

In effect, this is the empirical validation of Double Paradox: According to Wedeman’s time-series data, rising corruption and rapid growth moved in tandem with one another.

Wedeman’s discussion of anticorruption efforts adopts Gary Becker’s rational choice model in which the prevalence of corruption depends on the difference between a perpetrator’s expected value of committing a corrupt act, on one hand, and the expected value of remaining honest, on the other. In turn, the expected value of committing the corrupt act is the act’s payoff, less the probability of getting caught times the severity of punishment. Thus, more rigorous enforcement that increases the probability of apprehension, or/and increases the severity of punishment, will reduce corruption. With respect to the latter, Wedeman concludes from what he asserts are comparable samples of criminals apprehended for corrupt acts in China and in the U.S. that the sentences meted out in China were “exponentially harsher than those handed down in the United States.”

Despite this perhaps arguable finding, his journey through a labyrinth of Chinese data on corruption cases, criminals, and penalties over several decades leads to a balanced if inconclusive judgment that there is “little evidence that the extent of corruption has dramatically increased . . . but there is also little sign that corruption has decreased in recent years.” The recent blatant evidence of egregious corruption surrounding the Bo Xilai scandals in Chongqing and elsewhere in China casts some doubt on this conclusion.

Finally, returning to what I referred to earlier as “corruption with Chinese characteristics” suggests a fundamental question: Is the relationship between the two parts — growth and corruption — symbiotic or parasitic? How this question is answered is both timely and important: timely because of the current and impending slowdown of 2 to 3 percent or more in China’s growth rate; important because different answers have very different policy implications.

If the relationship is symbiotic, then growth in the past, powered by marketization, enlarged the pie on which corruption could feed, and this will continue in the future; and corruption, while facilitating growth in the past through the arbitraged movement from controlled prices to market prices, will also continue to facilitate growth in the future.

If the relationship is parasitic, then corruption extracts a toll from growth which, although not worrisome when growth was high, may become increasingly burdensome and contentious as growth declines in the future.

Mao formulated a parable to dismiss the question rather than answer it. Said he: “There is no need to squeeze all the toothpaste out of the tube [i.e., cadre corruption], you can’t get it all anyway, so why bother?”

In recent conversations with friends at fairly high ranks (Levels 4 and 5 in the multitier levels of the ccp’s aspirationally classless hierarchy), I’ve encountered a perspective that’s quite different from Mao’s dismissive one. Moreover, this current perspective adds a political dimension to the corruption and growth dichotomy, a dimension viewed by its protagonists as overriding the other two.

The tenor of this perspective can be summarized in the form of a syllogism:

  • Rising and conspicuous corruption is a serious threat to the legitimacy and continuity of the Chinese Communist Party.
  • As long as the state plays a major role in the economy, incentives for party members to engage in corrupt practices will be lucrative and irresistible. Therefore:
  • The state should retreat and withdraw from the economy, regardless of whether withdrawal would help or hinder future growth.

The inference from this syllogism is a paradox no less striking than the two paradoxes of Wedeman’s book. In effect, some staunch and aggressive ccp members are vigorous and articulate advocates of a more thoroughly marketized economy, and a diminished and minimal economic role for the state.

To be sure, this is not the only position currently discussed among China’s elite, nor is it necessarily the dominant one. Confronting a significant slowdown in China’s remarkably rapid growth of the past three decades, some influential voices have recently urged an expansion of public investment and an enlarged role for the already strong state-owned enterprises, at the expense of private business. Because Double Paradox emphasized the boost to corruption resulting from the transition to a marketized economy and the ensuing arbitraging between controlled- and market-driven prices, it is especially worthwhile to call attention to the fact that a move in the opposite direction that would enlarge the state’s economic role is no less (and in some ways probably even more) prone to corrupt practices.

A case in point is the so-called “Chongqing model” of development, and the Bo Xilai scandal referred to above that has followed in the wake of this megacity’s model. The model consisted of a huge expansion of public investment for housing, urban infrastructure, and reforestation — all financed by municipal bonds and vigorously advocated by the city’s populist mayor and former Politburo member, recently expelled from the Communist Party, Bo Xilai. Chongqing’s economic growth burgeoned in the short run, accompanied by heavy tolls exacted by the mayor’s family and other members of his entourage from construction contracts, as well as a massive accumulation of debt by the city itself.

Generalizing from this case, I’d suggest that public investment, which is ungoverned by competitive bidding, typically unmediated by market pricing, and nontransparent to outsiders constitutes an invitation to misallocation of resources, as well as misfeasance in behavior by those overseeing the process.

If the move from a planned to a market economy in the 1980s and 1990s opened the way for a surge of corruption, an attempted reversal back toward a more state-centered economy would be even more rife with corruption in the coming decade. When opportunities for corrupt practices are accessible, their curtailment depends on a rule of law that is overseen by an independent and uncorrupted judiciary. These institutions are yet to be developed in China.


Charles Wolf Jr. holds the distinguished corporate chair in international economics at the rand Corporation, and is a senior research fellow at the Hoover Institution.