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Competitive Private Sector

The degree to which powerful elites influence decisions and policy-making of the state (state capture) constraints the implementation of a fair, competitive, honest and transparent private sector and thus hinders broad-based economic development.

The ability of powerful economic interests to capture the state can be constrained by:

Economic Policy Liberalization[ii]

Deregulation of prices or other aspects of production or trade are important steps toward reducing opportunities for corruption.  Implicit price subsidies, in the form of tax and utility arrears, provide politicians and bureaucrats with discretionary power that is highly subject to abuse. Liberalization can help to reduce this discretionary power, but only if reform is undertaken in a transparent and nondiscriminatory way; otherwise, there is a risk that the reform process itself will be corrupted.

  Enhancing Greater Competition 

Enhancing competition, especially in concentrated sectors, by lowering barriers to entry, requiring competitive restructuring, and clarifying ownership structures are important elements toward creating a vibrant and corruption free private sector.

Transparency in formulating and implementing economic policy is crucial to combating corruption, especially in the areas of privatization and regulation.  Privatization bears considerable risks of corruption if not administered properly (For an account of flawed privatization efforts in Russia see Wedel. 1998).  Competitive restructuring of firms prior to privatization on a case-by-case basis can reduce possibilities for corruption, although political obstacles can impede this process. Competent agencies to administer law on competition policy, antimonopoly laws, and unfair trade practices can also help. Competition can also be strengthened by introducing greater transparency in the ownership structure and operations of firms and banks, through requirements on financial disclosure and arm’s-length relationships, efficient registries, and better supervision of their operations by independent regulatory bodies.

Regulatory Reform 

Proper regulation of utility companies and other industries in which competition remains imperfect is important to reducing corruption. The establishment of independent regulatory agencies, both at the central and at the local level where regulatory capture is most pronounced, can be effective in promoting efficiency and limiting opportunities for corruption, as long as such institutions operate with transparency (public hearings), simplicity (well defined, rules-based principles), and accountability (election of regulators or term limitations). Similar practices for regulating more routine aspects of business operations, such as registration (one-stop registration) and workplace safety (simple and clear rules for site inspections), are crucial to limiting harassment of businesses by bureaucrats and promoting new entry and growth. For all types of regulation, firms should be provided with low-cost methods of disputing administrative decisions. See the box below, for an overview of different approaches to business regulation that have been utilized in Hungary, Poland and the Czech Republic, three of the most successful of the Eastern and Central Europe’s transition countries.

Regulatory Reform in Hungary, Poland, and the Czech Republic  

The experience of Hungary, Poland, and the Czech Republic in reforming their economic regulations demonstrates that improved regulatory performance is not exclusively a function of reducing the number of regulations in force. Clear rules defining when government intervention is appropriate as well as improvements in the quality of regulatory instruments are critical in establishing effective regulations that are enforced in accordance with the rule of law.  

Hungary has focused on improving the quality of its regulations and on eliminating unnecessary regulations. Although nearly two-thirds of its firms are still required to obtain licenses in order to operate, the government ranks high in the quality of its operations, placing first out of 20 transition countries in the EBRD Governance Index. While Hungarian entrepreneurs display confidence about their relationship with government officials (only one-quarter of firms doubt the security of their property rights), ensuring the transparent and consistent application of official requirements will remain a critical challenge in the coming years, especially as functions shift to local governments.  

Poland's efforts to improve its regulatory environment have focused on establishing explicit rules to define when economic regulation is appropriate. The first step to reduce the role of government was taken in 1988 with passage of a liberal Law on Economic Activity. Over the next ten years, the absence of clear principles or criteria to guide government intervention led to the gradual but steady growth of licensing and permits requirements. By 1997, permit and licensing procedures were identified by entrepreneurs as the greatest obstacles to business operations.[iii] Poland’s leadership in the region in terms of private sector expansion and public sector contraction was being subtly undermined. With the second Law of Economic Activity, passed in 1999, the parliament has now sharply reduced the number of activities subject to licensing and created a comprehensive approach to licensing and permit requirements. Poland now faces the challenge of adapting its rules for creating and implementing regulations to bring them into accordance with its enacted regulatory principles. Distortions at the subnational government level in the implementation of licensing and permit rules, especially relating to land and construction, will also need to be tackled.

The Czech Republic began the transition period with a deep ideological commitment to giving free rein to market forces. The government sought to remove or limit regulations even in those areas where government involvement is usually seen as essential, such as in the securities market. In response to repeated crises, the present government is defining a more activist role for government, but little attention has been given to improving regulatory quality or to creating clear principles concerning government intervention in the economy. Regulatory expansion is occurring without sufficient attention to enhancing transparency and accountability. The problems caused by the successive approaches to regulation are evident: fully 50 percent of respondents doubt the security of their property rights and entrepreneurs believe that crime and corruption are their most serious obstacles. The Czech Republic's current predicament demonstrates that regulatory reform requires the creation of effective regulatory institutions and a framework of market rulesas much as it requires the elimination of unnecessary rules.  

Source: World Bank. 2000. Anticorruption in Transition. A Contribution to the Policy Debate. Washington, D.C., p. 50

Good Corporate Governance[iv]

Weak institutions for corporate governance not only result in inefficiency, they encourage corruption. Poorly governed managers often use their positions to extract favors from the state which they can later expropriate, rather than reinvest into restructuring their own firms, to avoid sharing their gains with other stakeholders. Corrupt behavior is often difficult to detect, especially in countries where transactions are obscured through the use of barter and other money surrogates as the means of payment. A wide array of corporate governance reforms have proven effective in curbing both incentives and opportunities for corruption, including: public disclosure of share ownership and cross-holdings; strong penalties for insider trading and pyramid schemes; the appointment of outsiders to boards of directors; the introduction of regular, published independent audits of financial accounts based on standardized rules; the establishment of an effective legal framework for the exercise of creditors’ rights; and the strong enforcement of ethical standards.

Business Associations

Business Associations are a means of engaging in collective action, providing a more powerful since unified voice and protecting the single firm from potential backlashes or competitive disadvantages while pursuing ethical business practices. Business associations can serve as a legitimate instruments to represent collective interests in the formulation of law and policy.

As shown in Figure 4.3[*], countries in which firms can find expression in legitimate collective associations are less likely to suffer problems of capture and administrative corruption.

Transnational Cooperation 

Foreign direct investment does not always import higher standards of corporate behavior into developing countries, especially those in which state capture and administrative corruption have already reached high levels.[v] Indeed, corruption in international trade, especially bribery of licensing and customs officials, is one of the most common and costly forms of corruption, resulting in the loss of billions of dollars each year in fiscal revenues in countries in transition. Proceeds from corruption often end up in foreign bank accounts or are laundered through foreign banks. The international community has mobilized to develop instruments against transnational corruption. A number of international conventions  that have the aim of intensifying and harmonizing the detection and punishment of transnational corruption, and which have potential importance for countries in transition, are available for signature (See below for an overview of these international conventions).

International Collective Action   

Council of Europe Criminal Law Convention on Corruption (European Treaty Series No. 173). Open for signature on January 27, 1999, the Convention requires signatories to make the following practices criminal offenses: bribery of public officials, trading in influence, laundering of proceeds of corruption, and other common forms of corruption. The Convention also provides for the investigation and prosecution of corruption, protection of persons collaborating with investigating or prosecuting authorities, and the adoption of measures on gathering evidence and confiscating proceeds. It provides for international cooperation—mutual assistance, extradition, and the provision of information—in the investigation and prosecution of corruption. A novel element of this convention is active monitoring by the Group of States against Corruption (GRECO).  

Council of Europe Civil Law Convention on Corruption.(European Treaty Series No. ). Open for signature on November 4, 1999, this Convention is the civil law counterpart of the Council of Europe’s Criminal Law Convention on Corruption. It is the first attempt to define common principles and rules at an international level in the field of civil law and corruption.  

The OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions. Patterned on the longstanding U.S. Foreign Corrupt Practices Act and effective on February 15, 1999, this Convention commits 34 signatory countries to adopt common rules to punish companies and individuals who engage in bribery. The Convention makes it a crime to offer, promise, or give a bribe to a foreign public official in order to obtain or retain business. A related text effectively prohibits tax deductibility for bribe payments made to foreign officials. Twenty countries have already changed their domestic laws in accordance with the Convention.  

The Council of Europe Convention on Laundering, Search, Seizure and Confiscation of the Proceeds from Crime. This Convention requires parties to the agreement to ensure that domestic law permits the seizure of property and bank records or transaction documents connected with suspected criminal activity, and criminalizes the acquisition, possession, concealment, or transfer of property one suspects as being involved in criminal activity. It further obliges signatory states to enforce confiscation orders made by a court of another signatory state, and to designate a central authority responsible for the communication with, and execution of orders of, other signatory states.  

The E.U. Council Directive on Prevention of the Use of the Financial System for the Purpose of Money Laundering. This Directive requires member states to stop transactions in which money laundering is suspected and obliges financial institutions in their countries to obtain identity documentation from clients before opening accounts and to provide evidence of suspicious transactions to authorities.

  [*] World Bank (2000).  Based on data from transition economies from the  Business Environment and Enterprise Performance Survey (BEEPS)

[i] This is largely based on World Bank. 2000. Anticorruption in Transition. A Contribution to the Policy Debate. Washington, D.C., pp. 47-52.

[ii] This section draws heavily from Broadman and Recanatini (2000).

[iii]Ewa Balcerowicz, Leszek Balcerowicz, Iraj Hashi, eds., “Barriers to Entry and Growth of Private Companies in Poland, the Czech Republic, Hungary, Albania and Lithuania,” CASE Reports No. 14, 1999.

[iv] This section draws heavily from Broadman and Recanatini (2000).

[v] See Hellman, Jones and Kaufmann (2000).

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