Understanding the economic crisis: Corruption a symptom, not the root cause

By Dhananath Fernando

Originally appeared on the Morning

The most common rationalisation of Sri Lanka’s economic crisis is to blame corruption, which is a complete mischaracterisation. This is not to say that corruption had no part in the crisis, but to place the blame solely on corruption would be inaccurate. In my view, there has been an economic policy problem which incentivised corruption, hence that is a problem that we have to fix, rather than trying to fix corruption. Corruption is just a symptom and policy is the root cause.

However, policy problems cannot be analysed in a vacuum, because simply having a policy does not mean everything will be alright. Policy has to be analysed based on the strength and stability of institutions.

One good example is the Fiscal Management (Responsibility) Act No.3 of 2003. According to the act (policy), the Government cannot exceed the budget deficit above 5% of the GDP. Since the act has enacted every budget we have presented, our budget deficit has been above 5%. Nothing has happened to any government for violating their own rules. We have the policy, but we do not have the institutions to enforce it or the stability or capacity for institutions to abide by the policy.

The anti-corruption commision is another good example. Many countries that wished to eradicate corruption have set up anti-corruption units, but when anti-corruption units are also corrupt, since they have been established by the existing powers, it is self-defeating.

Therefore, thinking that we can avoid an economic crisis or overcome the crisis by focusing on corruption as the sole measure shows a lack of depth. We have to evaluate the system somewhat more broadly to fix it.

A common question people ask is, “where are the assets for the loans we have taken?”. In that case, people think we have taken loans and syphoned that money out without investing. The deficit of the value of the projects and the loans we have taken is generally considered to be that which has been spent on corruption. While there have definitely been kickbacks from the projects, most of the money we have borrowed has been borrowed not for projects but to pay the interests of the loans we had borrowed before.

From our debt, about 74% has been used to pay interest or for exchange depreciation (40% for interest and 33% for currency depreciation). Since 1999, most of our debt has gone towards bad policies in the form of interest and for the exchange rate. At the point of borrowing money, similar to what happened in the Central Bank bond scam, there can be corruption, but the corruption is often an outcome of a bad policy or a poor system rather than a standalone problem.

Thus, rather than thinking about jailing the corrupt, it is easier to fill the gaps in the system where corruption takes place. This is where a market system is needed. The market system has the power to make the players of corruption uncompetitive, because corruption is costly. When the cost is too high, provided the consumer has a choice, they can shift to alternatives. Therefore, it is vitally important to set the market system straight and keep entry and exit barriers at a minimum.

Framework of the market system to think about corruption

How do we decide the project?

Generally, corruption takes place in projects and the decision-making processes of the projects. These mainly come as unsolicited proposals. Someone proposing a solution for a problem that even the government is unaware of falls under the category of unsolicited proposals. The government has the discretionary power to decide which projects are to be done and which projects are to be set aside. This is how quite a lot of construction projects, instead of education and healthcare, get priority.

Most projects under SOEs also fall under this category, which is why SOEs are considered vehicles of corruption and SOE reform is a must. Adhering to the National Physical Plan and getting it through Parliament is one way to minimise it.

Who does the project?

When the project is decided, the selection of the implementation partner is the next window for corruption. Again, it can be awarded through unsolicited proposals or there can be technical corruption where the specifications of the supplies are in favour of a selected supplier.

Unsolicited and competitive processes violate the market system, and on a technical level, corruption is very hard to detect even at the legal stage. However, with an open process on complaints and reevaluation, there is still room for improvement. There are also cases where even the competitive process is established due to a lack of trust in the system; the most suitable person doesn’t want to apply and go through the process.

Deciding on the price

The other point of corruption is when it comes to deciding on the price. It could be the interest rates on bonds, the contract value, or the price of the energy purchase. Price discovery is also a market-based process. When prices are allowed to be set without a market-based approach, there is room for corruption. That is how most of the energy agreements were signed and we borrowed money to pay the price. Rather than trying to fix the individual involved in corruption because the next person could repeat these same actions, it is advisable to fix the problem first.

Deciding the quality of materials

The fourth case is where even the people selected through the competitive process simply use inferior quality products. Our experiences in poor quality medicine at the Ministry of Health is just one example.

Corruption can take place in projects or in processes based on any of the above or a combination of any of the four. However, this takes place only when the decision-making power or discretionary power is given to someone who is not the owner of the risk or the investment. Otherwise, it leaves competition out or maintains information asymmetry for someone to benefit from.

In a market system where competition is given priority and prices are allowed to reflect the scarcity value of money, it naturally leaves corruption behind, but creating the information balance is not easy.

Therefore, while no market or government is perfect, a market system is a better system to avoid corruption, rather than expecting the government to eradicate corruption, since the government has no interest or incentive to do business or to eradicate corruption.

It is not about the private sector versus the government – it is all about a market system which incentivises transparency and minimises room for corruption. Our continuous failure to build that system was the reason for our fall (economic crisis) and we can only overcome it by fixing it, since it is the root cause, and not by fixing the symptom called corruption.

(Source: CBSL, Advocata)