Hello, welcome back to our course on corruption. This is week three, lecture one. And today we're going to be talking about the time and money costs that are imposed on individual firms that engage in corruption. The old way of thinking about corruption, particularly bribery, was that it was mildly beneficial to a firm. A firm could pay a bribe which would grease the wheels, in other words overcome barriers and allow that firm to do things that it was entitled to do. This way of thinking about corruption is called a static analysis. We looked at one transaction, and the effects of that one particular transaction. And some people, like Sam Huntington, or Nathaniel Leff, argued that not only is this beneficial to the firm, it's actually beneficial to these newly created countries in general. Because firms were coming in, overcoming barriers, doing things. Susan Rose-Ackerman in one of the most influential books written on corruption in the modern era suggested, wait a minute, corruption is not exogenous to the relationship between a business firm and the bureaucracy. Corruption is actually endogenous. It actually is part of the relationship. And therefore, corruption needs to be understood dynamically. It needs to be understood as part of the process that results in something. Rather than separate from that process. And two very important researchers, scholars, Daniel Kaufmann and Shang-Jin Wei, they took Susan Rose-Ackerman's suggestion and tested it, both theoretically and empirically. And their work, which is also very important work in understanding the effects of corruption at the firm level, found that a dynamic analysis yields a completely different result. Now if we were to take one single transaction, we might understand one person overcoming a barrier by paying a bribe to another person. If we treat corruption as endogenous to the relationship, we realize that there's an incentive for that other person, who has control over that barrier, to actually make that barrier larger. And therefore extract larger bribes to overcome the larger barrier. And that's in fact what happens, corruption is not a one time arrangement in which a barrier is overcome and then other things happen. Corruption turns out to be something that fuels ever greater bureaucratic obstacles and therefore ever larger bribes. Every single empirical study that has followed Kauffmanand Wei has found that firms that pay bribes spend more time and more money interacting with government than firms that don't. I pause because for some people who don't have a lot of experience with bribery in the business sector, they find this counter-intuitive. But let me repeat, every single empirical study that has followed Kauffman and Wei has found that firms that pay bribes spend more time and more money dealing with government than firms that don't. And these studies have used a variety of datasets and there's a surprising amount of data out there on this. They've compared a variety of firms, they've looked exclusively at qualities that one might think of as endemically corrupt. They've tried to take into account the ages of firms, the sizes of firms, the industry in which a firm is operating, every time they find the same result. A fairly robust result. When we bear down on these kinds of studies, we find that other costs are imposed by the payment of bribes. A payment of bribes counterintuitively increases the costs of raising capital. Now there are two ways in which this cost is imposed. One is, that firms that pay bribes are less attractive and therefore some kind of premium, or some kind of discount depending on whether it's bond or equity is imposed in the market by the market. And it effectively increases the cost of raising capital for these firms. Last year I had the opportunity to spend some time in a particular polity talking with bankers who were advising firms that were acquiring firms from another polity. And they were talking about something that they called the corruption discount. So the market is well aware and the market imposes these kinds of costs on the raising of capital by firms that pay bribes. The other mechanism through which the cost reverse in capital is increased from the paid bribes is that they're at a competitive disadvantage. The market for capital tends to be regulated, tends to be controlled by governments. These are firms that have already an awkward relationship with beaurocracies and a cost is imposed there. Paying bribes, corruption, decreases the rate of growth. Again, different studies using different data sets have found different results, but the results all show that it decreases the rate of growth. For example, a study done by Fisman & Svensson found that a 1% increase in the rate of paying bribes relative to the payment of bribes before, generally produces a 3% decrease in growth. Now the exact amount with which the paying of bribes decreases growth varies from region to region, industry to industry. But in general it decreases the rate of growth. This can be found specifically. For example, a study found that firms that pay bribes have slower market entry. For the reasons we've talked about before. Markets tend to be regulated, they have bureaucratic obstacles placed in front of them. That firms that don't pay bribes don't have put in front of them. They're at a competitive disadvantage. With respect to return on sales, corruption generally reduces return on sales probably because of misallocations of resources. Now this research has all been very quantitative. It's important to listen to the stories that business people in firms that have paid bribes tell about the costs that are imposed on them by paying bribes. Alexander Wrage, who is the chief executive of Trace International, a firm that works closely with businesses and countries that are trying to develop formulas, schemes, programs to reduce corruption, reports that people from multi-national companies describe a consistent trend. And that trend is, if they tried to overcome an obstacle that they think is relatively minor and they pay a bribe to do so, word spreads, the reputation becomes one of a firm that will pay a bribes. And the resulting increase in the number of demands becomes overwhelming or at least very costly. This is something that Jay Choy refers to as the ratcheting effect Almond & Syfert, they are not themselves business people. They're lawyers who work with business people. And I particularly like the last part of their story. The smell of corruption attracts other would-be bribees like flies, all of whom exert their leverage by threatening to report previous transgressions. In my own field work the phrase I've heard most frequently when talking to business people who paid bribes is that it is quite similar to adultery. That this hidden secret is always there, and it's always something that can be used to threaten them. It's something that doesn't go away. And of course, Elizabeth Spahn, who has long been active in the field of corruption research puts it very succinctly. The price goes up. In general when talking about the direct costs imposed by corruption, it's important to understand that corruption is endogenous to the relationship between a business firm and a bureaucracy. It's not exogenous, and therefore, the relationship between corruption and the rest of the relationship is a dynamic relationship rather than a static one time event that will only have one effect. And because of this, we find that firms that pay bribes spend more time and money dealing with bureaucracies. They have to pay more money to raise capital. They have slower rates of growth, including sales growth. Thank you, and I look forward to our next lecture.