Friday, September 1

Pundita Golden Oldie: House of Cards

Originally published September 2005
Reviewing a reader's question about corruption in Peru's construction industry reminds Pundita that two US states famous for corruption, Mississippi and Louisiana, are undertaking a massive reconstruction effort. So now is good time to bone up on a report about corruption in the construction industry and guidelines for averting the worst abuse of public monies --

September 2
"Dear Pundita:
I've lived in Latin America on and off for years. I've often wondered how US aid money gets from taxpayers' pockets to corrupt officials' private bank accounts. A flow chart would be fascinating (and heartbreaking).

The stealing going on must be tremendous. There is virtually no investment in infrastructure in most Latin American cities. Public works is a complete nil. I agree with one of your basic assessments (my paraphrase): it is not that rich people -- say, in Latin America -- are particularly bad or twisted, but they do not tax themselves.

Latin America does not have an IRS-type agency that has the Fear of God as a backstop. Basically, nobody pays taxes at any significant level. Or at minimum, there doesn't seem to be any honest collection and distribution system.

In any case, would you be willing to explain just how corruption works? Take for example some Minister -- say the Director, Ministerio de Vivienda of Peru. The public monies coming in cannot be all that large. Foreign aid on the other hand represents a respectable pile of cash.

How does our director go about getting his divvy of US foreign aid?
Doug in Seattle"

Dear Doug:
Actually the rich are soaked in countries without a fair tax code and enforced collection system; the taxation on the rich is whatever the traffic will bear. However, the taxation is under the table, as I pointed out in Paw a Revenuer's at the door....

In other words, there is always de facto taxation in effect. If you have to pay bribes to get anything done that's a tax albeit an illegal one.

The biggest problem with this kind of taxation is that the revenue, if it can be called that, is not spent on works that benefit the public as a whole. That sets in motion a vicious cycle. The roads or electricity will be somewhat reliable in a rich neighborhood, thanks to bribes, but because other regions or sections of a city go without, the rich end up spending exorbitant monies to do business or simply function outside their own neighborhood.

That much human stupidity is hysterically funny when looked at from the longest view. More than once Pundita has had to tell a bald-faced lie, in order to explain away her peals of laughter while listening to the complaints of the rich in countries that run on bribes.

"Bah! Nothing works in this crazy country! Our entire shipment rotted on the docks again because the roads washed out! I can't tell you how much in bribes it cost to get things moving again!"

If you see someone who is otherwise sane whacking himself in the shins with a tire iron then complaining, "I can't walk," at first you feel sympathy. But once you've heard, "This is my tradition" a few times it's hard not to think of The Three Stooges.

The good news: that much stupidity is severely punished in a globalized trade system unless there is an external force propping it up. Enter foreign aid and development loans.

So I'm going to throw you a curve ball. Even if the aid agency or development bank could somehow prevent corruption, which often can't be done without draconian, expensive oversight measures, you're not even out of the gate.

The truth is that as long as many governments have a way to stave off a realistic, enforced tax code, they'll take it. That's because the wealthy faction that put them in power throws a hissy fit when confronted with an iron-clad tax code and collection enforcement.

The World Bank has learned this lesson the hard way and USAID is catching up.(1) That's why they've gone gaga over remittances. The reasoning is that if they have to contribute to tax delinquency, at least work it so they're not the only ones. Encourage chump immigrants to send their hard-earned money over and above taxes back home.

In this way, the chumps continue to support the home administration's habit of blowing revenue to keep the rich from overthrowing them. Then we're right back at shin whacking.

Here you might ask why the wealthiest nations don't simply shut off development loans and aid except for outright disasters. The answer is that aid and development banking are mega-industries.

Even if you only gave aid in the form of outright cash, you'd be helping to support the banking sector because you have to collect, transfer and disburse the cash. However, most aid is in the form of goods or service, which helps support contractors and subcontractors.

Same principle applies to development banks. See Development Banks under the Pundita Selected Essays on the sidebar.

The industry of being helpful to the poor supports so many livelihoods that if you somehow managed the impossible and shut it down, it would spring up again virtually overnight.

The development loan industry even supports the industry that's grown up to invest in helping the poorest in the poorest nations, if you can feature that. There are funds you can invest in that specialize in providing micro loans to the world's poorest entrepreneurs. You don't get a big return, of course, but if you want to invest in 'socially responsible' projects, an industry has arisen to tend to that desire.

I hasten to add that investing in micro-projects, which can be as small as a few hundred dollars, is a good idea in principle. And in practice micro-investing brings genuine and generally corruption-free assistance to the neediest and hardest working.

Yet as soon as the poor expand beyond a tiny neighborhood business, they run into the same problems the rich run into in their country. The electricity fails during business hours, the roads are washed out, the garbage isn't picked up, and so on down the long list. So what do the fledgling entrepreneurs end up doing? They pay more bribe money.

How to break the vicious cycle? The US government has hit on the idea of promoting genuine democracy and election reforms in the poorest countries. The reasoning is that if more people in the poorest countries are brought into the voting and governing process, collective wisdom will break self-destructive traditions.

As to how aid money gets from Americans' bank accounts into the hands of corrupt officials, it depends on how the aid transfer is set up and the form it takes. Money can be skimmed or outright stolen by a virtually infinite variety of means. Close oversight, which costs a lot of money, is the only way to insure that most of the aid won't wend its way into the wrong hands.

With regard to corruption in public construction works, you will find the 2005 report by Transparency International of interest. You might want to first read their press release, which is cheerily titled, "A world built on bribes?"

Or go directly to Global Corruption Report 2005, which focuses on corruption in construction and post-conflict reconstruction. And ahem the guidelines and warnings apply as well to post-disaster reconstruction.

1) USAID Anticorruption Strategy 2005 (PDF).

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