Endogenous corruption in emerging industrial relations

Studies and international surveys have long argued that corruption is rampant in post-communist Central and Eastern Europe. But little attention has been paid to corruption in the private, or newly privatised, sector. This paper introduces "endogenous" corruption: a new form of corruption that the author says has arisen during the privatisation process in transitioning economies. Its major finding is that this type of corruption occurs when mutual benefits are financed at the expense of outside owners, who lose out.

The author shows how endogenous corruption has flourished in situations where ownership claims are dispersed, capital markets are underdeveloped, product competition is hindered and managers are willing to behave opportunistically.

The paper illustrates how this has created new hindrances to reform efforts. Firstly, by devastating factor allocation so hampering productivity and keeping prices high. Secondly, through the interconnectedness of commodities, it reduces profits in other industries and creates substantial efficiency losses for the whole economy.

The results of the research suggest that active economic competition creates conditions that discourage endogenous corruption, especially policies that are strongly oriented toward liberalisation and application of hard budget constraints.

The author concludes that traditional anti-corruption strategies don’t effectively combat endogenous corruption, because whistleblowers in the private sector have a strong material interest in keeping quiet. Eradication of endogenous corruption instead requires a more subtle approach, one tailored to the sources of wrongdoing.

The paper recommends these counter-endogenous corruption measures:

• creation of an effective privatisation strategy that produces concentrated outside ownership for privatised firms, and does not favor outsiders, no matter how politically disadvantageous
• countries that have already privatised the majority of their state-owned assets should develop commercial laws that limit inside dealing, conflict of interest, and protect minority shareholders
• countries should raise accounting standards, increase transparency of corporate decision-making processes, and encourage labor market competition.