20925
September 2000
ANTICORRUPTION IN
TRANSITION
A Contribution to the
Policy Debate
A WORLD FREE OF POVERTY



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Copyright 0 2000
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First printing September 2000
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TABLE OF CONTENTS
Foreword.................................................................vii
Acknowledgments                          .........................................................ix
Abbreviations     ............................................................xi
Executive Summary                          .......................................................xiii
Chapter 1 The Level and Pattern of Corruption in the Transition Countries..           ............1
The Extent of Corruption in the Transition Countries                        ........................6
Unbundling Corruption in Transition           ................................       .........7
Measuring Administrative Corruption                                  ................7.......... .............7
Measuring State Capture                ...........................................    .......9
Developing a Typology of Corruption in Transition.................                   .............. 14
Chapter 2 The Economic and Social Consequences of Corruption in Transition Countries........18
Investment and Growth                                         ................................................... 18
Poverty...................................................................20
Inequality.....   .......................................................21
Fiscal Implications                     ......................................................21
Credibility of the State .........................................................22
Chapter 3 The Origins of Corruption in Transition Countries..............               ..........25
Institutional Legacies....................................................26
Economic Legacies......................................................28
Transition Paths...... ..................................................29
The Redistribution of Assets...............................................32
The Role of Foreign Investment and Assistance..................................33
Vicious or Virtuous Circle?.................................................35
Chapter 4 A Multi-pronged Strategy for Combating Corruption.......................39
Increasing the Accountability of Political Leaders.................................40
Strengthening Institutional Restraints..........................................41
Strengthening Civil Society Participation.......................................44
The Role of the Media....................................................46
Creating a Competitive Private Sector          ................................     .........47
Economic Policy Reform ............................................................................ 48
Enhancing Competition                     ...............................................49
Regulatory Reform .................................................................................. 49
Corporate Governance                     ................................................50
Business Associations                    ................................................51
Transnational Cooperation .... .........................................51
Reforming Public Sector Management.....................................52
The Multi-pronged Approach .................................................56


iv
Chapter 5 Designing Effective Anticorruption Strategies............................58
Medium State Capture/Medium Administrative Corruption..........................59
Medium State Capture/High Administrative Corruption..............................63
High State Capture/Medium Administrative Corruption..............................66
High State Capture/High Administrative Corruption...............................71
Implementing an Anticorruption Strategy......................................74
Common strategic challenges............................................75
Sequencing........................................................77
Sustainability....................................................... 77
Chapter 6 Conclusion...................................................... 79
References     ............................................................... 82
Annex I Methodological Annex for Figures in the Text..............................89
List of Text Boxes
Box 1.1:      The Concept of State Capture........................................ 3
Box 1.2:      The Business Environment and Enterprise Performance Survey................ 5
Box 1.3:      Who Captures Whom?............9
Box 1.4:      Corruption When Transition is Stalled.....................................11
Box 1.5:      Corruption in the Judiciary....................................              ...... 14
Box 3. 1:     Comparison of the Transition in Poland and Russia   ............................ 30
Box 4.1:      Disclosures of Conflict of Interest                         ...................3.... ............40
Box 4.2:      Political Party Financing: Experience And Mechanisms................        ..... 42
Box 4.3:      Transparency and Recourse in Administrative Decisionmaking    ...........   ..... 43
Box 4.4:      Anti-money Laundering         ........................................... 44
Box 4.5:      Giving the People Voice       ........................................... 45
Box 4.6:      Challenges of Confronting State Capture in the Energy Sector      ................. 48
Box 4.7:      Regulatory Reform in Hungary, Poland, and the Czech Republic             ...............50
Box 4.8:      Business Ethics                                      .................................................51
Box 4.9:      International Collective Action         ...............................    ........52
Box 4.10:     Tackling Informal Payments with Structual Reforms in the Health Sector ..............55
Box 5.1:      Poland te    op   Vie............. ............................................62
Box 5.2:      Albania       .........................................................65
Box 5.3:      Post-conflict Environments            ....................................   ..... 68
Box 5.4:      Windows of Opportunity in Croatia and the Slovak Republic.................. 69
Box 5. 5:     Latvia........ ................................................70


V
Box 5.6:      Azerbaijan ....................................................72
Box 5.7:      Russia                    .......................................................74
Box 5.8:      Diagnosing the Problem...........................................76
Box 6. 1:     Lessons from International Experience     ................................. 80
List of Tables
Table 1.1     Share of Firms Affected by Different Forms of State Capture   ........    ......... 13
List of Figures
Figure 1:     World-wide Perceptions of Corruption        ............................   ..... xiv
Figure 2:     State Capture Index ................      .      ......................  ..... xvi
Figure 3:     Administrative Corruption           .................................... ..... xvii
Figure 4:     Typology of Corruption            .......................................   .... xviii
Figure 5:     Resource Endowments and Corruption         ...........................    ...... xx
Figure 6:     Statehood and Corruption........................................... xx
Figure 7:     Multi-pronged Strategy: Addressing State Capture and Administrative Corruption...... xxii
Figure 1.1:   World-wide Perceptions of Corruption                        ...................6... ..........6
Figure 1.2:   Administrative Corruption           .................................... ..... 8
Figure 1.3:   State Capture Index        .................................................. 13
Figure 1.4:   Typology of Corruption .........................5.....             ............15
Figure 2.1:   Corruption and Output Decline        ..............................     ........ 19
Figure 2.2:   Corruption and Poverty ........................................... 20
Figure 2.3:   Corruption and Income Inequality .................................... 21
Figure 2.4:   The Unofficial Economy.........  .......................              .........21
Figure 2.5:   Quality of Macroeconomic Governance       .......................      ......... 22
Figure 2.6:   Organized Crime as a Problem Doing Business     ................................. 23
Figure 3.1:   Statehood and Corruption............................................... 27
Figure 3.2:   Habsburg Legacy and Corruption          ..............................    ...... 27
Figure 3.3:   Democracy and Corruption            ....................................  ..... 28
Figure 3.4:   Resource Endowments and Corruption         ...........................    ...... 28
Figure 3.5:   Change in Leadership and Corruption.  ................................. 30
Figure 3.6:   Economic Reform and Civil Liberties and State Capture  ...............    ...... 31
Figure 3.7:   Foreign Direct Investment and Corruption      .........................  ..... 34
Figure 3.8:   Foreign Direct Investment in High-corruption Countries  ................  ..... 35
Figure 3.9:   Variation Within and Between Sub-regions.......................... 35
Figure 4.1:   Multi-pronged Strategy: Addressing State Capture and Administrative Corruption......39
Figure 4.2:   Media Repression                                   ..................... ..................  47
Figure 4.3:   Business Associations and Corruption   ................................. 51
Figure 6.1:   Change in the Extent of Bribery During the Last 5 Years  ............  ........79



Vii
Foreword
With the increasing recognition across the globe of the damaging effects of corruption on
economic growth and social stability, the demand for practical strategies to reduce corruption has
grown dramatically. The problem is not confined to any particular region, and developed,
developing and transition countries alike are confronting these challenges. In the countries of
Central and Eastern Europe, the Baltics, and the Commonwealth of Independent States, the
simultaneous processes of developing a market economy, designing new political and social
institutions and redistributing social assets have created fertile ground for corruption. Many
governments throughout the region have made combating corruption a priority and have turned
to the World Bank for assistance in designing feasible anticorruption strategies.
Our initial experience in providing anticorruption assistance has shown that while much is
known about the proximate causes and consequences of corruption, we know comparatively little
about the economic, political and historical factors underlying the persistence of corruption in
the region. Moreover, we have seen through our assistance efforts that the extent and nature of
the problem differ substantially across the transition countries requiring a differentiated approach
to the prioritization and sequencing of reforms.
This report seeks to unbundle the varied practices of corruption to identify and compare different
patterns of the problem across transition countries. It then draws out lessons for tailoring
anticorruption strategies to address the variation across the region in an effort to target reforms
more effectively. The report draws on a multitude of sources of ongoing research and lessons of
experience, including the World Bank's work in this area. However, the report does not seek to
review the World Bank's operations or set specific strategic guidelines for its operational work in
this area. Instead, the report is intended as a contribution to the growing policy dialogue on
developing practical strategies for reducing corruption. As more and more countries seek to
implement anticorruption programs, it is critical for the World Bank and other institutions to
continue to enhance this dialogue with both the lessons of experience and with new approaches
designed to tackle the roots of corruption.
Johannes F. Linn
Vice President
Europe and Central Asia



ix
Acknowledgments
The report was prepared by a core team led by Sanjay Pradhan and comprising James Anderson,
Joel Hellman, Geraint Jones (EBRD and the World Bank), Bill Moore, Helga Muller, Randi
Ryterman, and Helen Sutch.
The report benefited from a large number of contributions both from within the World Bank and
from external partners. The analysis and measurement of state capture, first published in the
EBRD Transition Report 1999, is based on a collaborative research project between the Policy
Studies Programme of the EBRD and the World Bank (WBI) under the direction of Joel Hellman
and Daniel Kaufmann, who also provided important advice and inputs. We are grateful to the
Office of the Chief Economist of the EBRD for their partnership.
Contributors from the World Bank include: Luba Beardsley, Sandra Bloemenkamp, Harry
Broadman, Lilia Burunciuc, Peter Dean, Jean-Jacques Dethier, Nora Dudwick, Itzhak Goldberg,
Christine Jones, Alma Kanani, Vitaliy Kartamychev, loannis Kessides, Kathleen Kuehnast,
Kathy Lalazarian, Maureen Lewis, Laszlo Lovei, Alexandre Marc, Allister Moon, Amitabha
Mukherjee, Mark Nelson, Madeleine O'Donnell, Jana Orac, Neil Parison, Friedrich Peloschek,
Alexey Proskuryakov, Francesca Recanatini, Gary Reid, Ana Revenga, Sue Rutledge, Mary
Sheehan, Maria Shkaratan, Rick Stapenhurst, Margret Thalwitz, Peter Thomson, Cari Votava,
Shang-Jin Wei, and Deborah Wetzel. Lilian Canamaso, Valery Ciancio, Miranda Cookson, and
Virginia Sapinoso provided administrative support.
External contributors include: Vladimir Brovkin (US; Transnational Center for Crime and
Corruption), Milan Cech (The Czech Republic; Police), Bertrand de Speville (consultant, former
Commissioner of Hong Kong Independent Commission Against Corruption), Pavol Fric (The
Czech Republic; Charles University), Irina Borisovna Garsia (The Russian Federation; RIA
Novosty Agency), Fiona Harrison (UK; Article 19), Keith Henderson (US; Transnational Center
for Crime and Corruption), Leslie Holmes (Australia; University of Melbourne), Serhyi Holovati
(Ukraine; President of the Ukrainian Legal Foundation; Member of Parliament; former Minister
of Justice), Evzen Kocenda (The Czech Republic; CERGE), Lubomir Lizal (The Czech
Republic; CERGE), Mario Nuti (UK; London Business School), Sam Paul (Consultant), Mark
Philp (UK; University of Oxford), Martin Rhodes (European University Institute), Emilia
Sicakova (The Slovak Republic; Transparency International), Vladimir Svetozarov (The Russian
Federation; National Press Institute), Emil Tsenkov (Bulgaria; Coalition 2000), Joel Turkewitz
(Consultant), Janine Wedel (Consultant), Daniela Zemanovicova (The Slovak Republic;
Transparency International).
An interim, summary version of this document was reviewed by ECA's External Advisory Board
(EAB) on Governance. The EAB is chaired by Professor Leszek Balcerwowicz (Poland; then
Deputy Prime Minister and Minister of Finance), and consists of 16 distinguished individuals
from government, academia, NGOs and the private sector: Vladimir Gligorov (Macedonia;
Research Fellow; Wiener Institut fuer Internationale Wirtschaftsvergleiche); Serhiy Holovaty
(Ukraine; President of the Ukrainian Legal Foundation; Member of Parliament; former Minister
of Justice); Lena Kolarska-Bobinska (Poland; Director of Institute of Public Affairs); Miklos
Marshall (Hungary; Transparency International); Ivan Miklos (Slovak Republic; Deputy Prime


x
Minister); Vira Nanivska (Ukraine; Director, International Center for Policy Studies (ICPS));
Professor Richard Pipes (U.S.; Harvard University); Alexandre Rondeli (Georgia; Director,
International Policy Research and Analysis Center, Ministry of Foreign Affairs); Georgyi
Satarov (The Russian Federation; President of the  Indem  Foundation (Infomatics for
Democracy), former Assistant to President Boris Yeltsin); Daulet Sembayev (Kazakhstan;
Chairman of the Association of Financiers of Kazakhstan, Chairman, Advisory Board,
Kazkommertsbank); Valeriu Stoica (Romania; Deputy Prime Minister, Minister of Justice); Vita
Terauda (Latvia; Executive Director of Soros Foundation, former Minister of State Reform);
Ugnius Trumpa (Lithuania; Vice President, Lithuanian Free Market Institute); Laszlo Urban
(Hungary; Deputy CEO of Postabank); and Dimitrii Vasiliev (Russia; Chairman, Institute for
Corporate Governance).
The document has been reviewed by the ECA Regional Management Team chaired by Johannes
Linn, by the Public Sector Board chaired by Cheryl Gray (internal peer reviewer), and by
Professor Susan Rose-Ackerman (external peer reviewer, Yale University). Written comments
were provided by: Basil Kavalsky, Brian Levy, Nick Manning, Rick Messick, Pradeep Mitra, Ian
Newport, Marcelo Selowsky, Shekhar Shah, and Andrew Vorkink.
The participation of more than 3,000 enterprise managers in the Business Environment and
Enterprise Performance Survey (BEEPS), and the participation of NGOs in 17 transition
countries in a brief survey on civil society, are gratefully acknowledged. The BEEPS was
conducted and financed by the Policy Studies Programme of the EBRD and the Word Bank
Institute. The support of Nicholas Stern and Steven Fries of the EBRD is gratefully
acknowledged.
The authors would like to thank the Danish, Italian, and Norwegian Governments, UK-DFID,
and USAID for their financial support.


xi
Abbreviations
ACER         Albanian Center for Economic Research
AIDS         Acquired Immune Deficiency Syndrome
BEEPS        Business Environment and Enterprise Performance Survey
CEE          Central and Eastern Europe
CIS          Commonwealth of Independent States
EBRD         European Bank for Reconstruction and Development
EU           European Union
FDI          Foreign Direct Investment
FSU          Former Soviet Union
GDP          Gross Domestic Product
GORBI        Georgian Opinion Research Business International
KGB          Komitet Gosudarstvennoy Bezopasnosti
NGOs         Non-Governmental Organizations
OECD         Organisation for Economic Co-operation and Development
SMEs         Small- and Medium-sized Enterprises
SOEs         State Owned Enterprises
UK           United Kingdom
UNICRI       United Nations Interregional Crime and Justice Research Institute
US           United States
USAID        United States Agency for International Development
USD          United States Dollar
WBI          World Bank Institute



Xii
Executive Summary
More than a decade into the simultaneous political and economic transitions in Eastern
Europe and the former Soviet Union, dynamic market economies have been created and states
have been reshaped, but the boundaries between state and economy remain murky. The fusion of
the state and the economy that characterized the communist system has been replaced in most of
the countries by a new order, but one in which the separation of private and public interests has
not been adequately defined. Corruption in the region is developing new dimensions, reaching
new heights, and posing new challenges.
The transition countries have been engaged in a concentrated process of defining the
basic rules and institutions to govern their economies and societies, while at the same time
redistributing the bulk of their assets. In many countries, corruption has had a significant impact
on this process, encoding advantages in these new rules and institutions for narrow vested
interests and distorting the path of economic and political development. Media reports
throughout the region tell of powerful firms and individual "oligarchs" buying off politicians and
bureaucrats to shape the legal, policy, and regulatory environments in their own interests.
Numerous high-profile corruption scandals have revealed politicians abusing their authority to
shift public resources to themselves and their allies through well-hidden stakes in a complex web
of private and public companies. In many countries, the public perceives corruption to be woven
into the basic institutional framework, undermining governance and weakening the credibility of
the state.
These public perceptions of pervasive corruption in parts of the region are supported by a
wide range of international comparisons. A summary of 12 of the most widely known
international corruption indices, depicted in Figure 1, suggests that perceptions of corruption in
the Commonwealth of Independent States (CIS) are among the highest of all countries included.
While corruption levels in the countries of Central and Eastern Europe and the Baltics (CEE) are
lower, they are still on par with the countries of Latin America and the Middle East, at levels
considerably higher than those in the OECD countries.


xiv
Figure 1. World-wide Perceptions of Corruption
0.8
0.6  -__             __-  _- __- - -          -               -       -
.2 0 .4 -_ _ -~
0.6
0)
CL
0
0.2  -  __
OECD  Southeast Asia  Middle East  Central and  Latin America  Sub-Saharan  South Asia  CIS
and North  Eastern        Africa
Africa  Europe and
the Baltics
The thin line at the top of each bar represents the statistical margin of error (based on a single standard deviation)
calculated on the basis of the aggregated indicators. Source: Kaufmann, Kraay, and Zoido-Labaton (1999a). See
Annex 1 for a description of the calculation of this summary index and the margins of error.
The expansion of corruption in the decade of transition has coincided with a sharp, initial
decline in output and significantly higher levels of poverty and inequality across the region.
Though unraveling the lines of causality may be difficult, recent empirical studies have
documented the considerable economic and social costs of corruption. One conclusion of these
studies raises particular concern: it is the poor who bear the heaviest brunt of corruption.
Corruption weakens public service delivery, misdirects public resources, and holds back the
growth that is necessary to pull people out of poverty. Stories abound of pension payments
postponed and disability benefits denied, all because the requisite bribes were not paid. Measures
of the aggregate social costs of the problem do not reveal the human suffering wrought by
corruption.
In those countries where the problem is most entrenched, corruption undermines the
driving forces behind reform. New firms are driven into the underground economy. Vital
resources are siphoned off shore. Foreign investors turn away in frustration. As a result, some
countries risk becoming trapped in a vicious circle in which pervasive corruption reduces public
revenues, undermines public trust, and weakens the credibility of the state, unless decisive
leadership can push through the necessary reforms.
Recognizing that corruption is one of the most serious obstacles to development, the
World Bank has made combating corruption a central institutional priority. At the same time, a
number of transition countries have begun to request assistance from the World Bank
specifically to target corruption. Since 1997, the World Bank has intensively developed
diagnostic tools, technical assistance, training programs, and lending instruments targeted toward
reducing corruption in transition countries. This report does not focus on World Bank experience
per se. Rather, it focuses on the diagnosis of corruption across transition countries and the


Xv
implications for country strategies on the ground. The World Bank stands ready to support
countries' anticorruption programs, in partnership with other domestic and international actors.
Though still in the early stages of development, the experience of anticorruption
programs to date has produced mixed results. Ambitious anticorruption campaigns in several
countries have floundered at the implementation stage. Key structural reforms have been blocked
by powerful vested interests. In some cases, politicians have hijacked the anticorruption agenda
and used it to attack their rivals. Governments in the region have tended to prefer strengthening
enforcement mechanisms to addressing the structural roots of the problem. One reason for the
difficulties has been an overemphasis on technocratic measures in a uniform approach that does
not take into account important differences among countries in the power and concentration of
vested interests, the capacity of the state, and the channels of accountability between the state
and civil society.
Confronting corruption in transition countries requires a more complex approach that
recognizes the diverse factors underlying the persistence of corruption and provides a foundation
for tailoring strategies to the particular contours of the problem in different countries. This report
provides an approach to meeting these challenges. It begins by unbundling the problem of
corruption, recognizing that what is generally treated as a unidimensional phenomenon
encompasses a range of different interactions within the state and between the state and society,
each with its own dynamics. On this basis, a new typology of corruption is developed for the
transition countries to explore differences in the origins and consequences of corruption in
distinct groups of countries. Specific policy recommendations are then tailored for each group,
drawing from a common set of institutional and policy reforms, with emphasis on how to target
anticorruption efforts, how to sequence reforms, and how to calibrate realistic expectations in
different contexts.
The report relies on an important new source of data on governance and corruption in
transition economies-the 1999 Business Environment and Enterprise Performance Survey
(BEEPS) commissioned jointly by the World Bank and the European Bank for Reconstruction
and Development. The BEEPS is a firm-level survey of more than 3,000 enterprise owners and
senior managers in 22 transition countries. It provides new and more robust measures of a
number of forms of corruption across transition countries from the point of view of firms. In
addition, data from a wealth of audit reports, empirical studies, cross-country household surveys,
and detailed diagnostic studies in selected transition countries are also consulted to provide a
broader picture of corruption from the perspectives of households and state officials. The
combination of these studies with the BEEPS data provides a powerful and balanced foundation
from which to understand the depth and contours of the problem of corruption within and across
countries.
The Level and Pattern of Corruption in the Transition Countries
The report seeks to unbundle the phenomenon of corruption, placing primary emphasis
on the distinction between state capture and administrative corruption. State capture refers to
the actions of individuals, groups, or firms both in the public and private sectors to influence the
formation of laws, regulations, decrees, and other government policies to their own advantage as
a result of the illicit and non-transparent provision of private benefits to public officials. There


Xvi
are many different forms of the problem. Distinctions can be drawn between the types of
institutions subject to capture-the legislature, the executive, the judiciary, or regulatory
agencies and the types of actors engaged in the capturing-private firms, political leaders, or
narrow interest groups. Yet all forms of state capture are directed toward extracting rents from
the state for a narrow range of individuals, firms, or sectors through distorting the basic legal and
regulatory framework with potentially enormous losses for the society at large. They thrive
where economic power is highly concentrated, countervailing social interests are weak, and the
formal channels of political influence and interest intermediation are underdeveloped.
By investigating the channels through which firms seek to influence the state, the BEEPS
survey represents the first attempt to measure some aspects of the incidence of capture across the
transition countries, albeit representing only the problem of capture by firms (as opposed to other
individuals or groups). The survey identified a number of specific activities that fall within the
definition of state capture, including: the "sale" of Parliamentary votes and presidential decrees
to private interests; the sale of civil and criminal court decisions to private interests; corrupt
mishandling of central bank funds; and illegal contributions by private actors to political parties.
Firms were asked to assess the direct impact on their business from each of these activities,
regardless of whether they engaged in such activities themselves. Thus, capture is measured not
by how many firms engage in it, but by the share of firms whose business is directly affected by
it. Figure 2 presents an aggregate index of the impact of state capture across the transition
countries based on the dimensions listed above.
Figure 2. State Capture Index (share of firms affected by state capture)
50
40   -    -  -  __-  -_   - -       - --       --                  -
 II1
40
20
o0 I
10
)~  ~   C (~ C~  ~   ~   C)~C~      >  l  (  C   ~      C
-) C           c   c 5
'.'   2  C:                         'a                 >
E       -E
N    Q)              N                         >~. D o ~
<N                    M                           -
The thin line at the top of each bar represents the statistical margin of error (based on a single standard deviation)
calculated for each country within the sample. Source: Hellman, Jones, and Kaufmann (2000a).


Xvii
While state capture encodes advantages for particular individuals or groups in the basic
legal or regulatory framework, administrative corruption refers to the intentional imposition of
distortions in the prescribed implementation of existing laws, rules, and regulations to provide
advantages to either state or non-state actors as a result of the illicit and non-transparent
provision of private gains to public officials. The classic example of administrative corruption is
that of a hapless shop owner forced to pay bribes to a seemingly endless stream of official
inspectors to overlook minor (or possibly major) infractions of existing regulations. Beyond such
forms of extortion, administrative corruption also includes such familiar examples of "grease
payments" as bribes to gain licenses, to smooth customs procedures, to win public procurement
contracts, or to be given priority in the provision of a variety of other government services.
Finally, state officials can simply misdirect public funds under their control for their own or their
family's direct financial benefit. At the root of this form of corruption is discretion on the part of
public officials to grant selective exemptions, to prioritize the delivery of public services, or to
discriminate in the application of rules and regulations.
The BEEPS survey also provides data to develop an aggregate measure of administrative
corruption across the transition countries. Firms estimated the share of their revenues that they
typically pay per annum in unofficial payments to public officials in order to "get things done."
The average bribe share by country is presented in Figure 3.
Figure 3. Administrative Corruption
(bribes as a share of annual revenues)
7
6I
5I
.
0 4  -_           _   __          _ _
2
2  -~
Tethin line at the top of each bar represents the statistical margin of error (based on a single standard deviation)
calculated for each country within the sample. Source: BEEPS.


Xviii
Across the CIS, average payments for administrative corruption constitute 3.7 percent of
firm revenues; the share falls to 2.2 percent of revenues in CEE. Yet measuring administrative
corruption as a share of firm revenues does not convey the full weight of the burden of this form
of corruption. Based on a rough estimate of profit margins across the region, firms in countries
with the highest levels of administrative corruption can pay up to 25 percent of their profits in
such payments.
As the BEEPS survey measures only some of the diverse forms of state capture and
administrative corruption, it undoubtedly underestimates the extent of both problems across the
region. Neither form of corruption is limited exclusively to acts initiated by or involving private
sector firms. Public officials themselves can misuse their authority to shape the rules of the
game or to distort the implementation of state policy to benefit their own private financial
interests. This problem of conflict of interest spans both types of corruption, especially in
transition countries. Though all countries in the region (as well as most advanced countries
across the globe) continue to have problems with both state capture and administrative
corruption, the report demonstrates that the nature and variation of their interaction in the context
of transition raises different challenges for developing effective anticorruption strategies.
The report presents a typology of corruption based on the interaction of state capture and
administrative corruption. Figure 4 shows a two-by-two matrix of countries with each axis
ranging from "high" to "medium" denoting the relative level of each form of corruption. The
term "medium" is chosen as a reminder that both administrative corruption and state capture
continue to be serious problems in every country of the region.
Figure 4. Typology of Corruption
Medium                                   High
45
40                                                           Azerbaijan
m Moldova               High
35
Latvia              m Russia          a Ukraine Kyrgyz Rep.
30                m Bulgaria
2 Croatia
.E 25                   Slovak Rep,       Rorania    m Georgia
* 20
15
~ 15                                 Albania
Poland y   Czech    m m,h Kazakhstan                      Medium
10            Estonia    Rep.      Lithuania
Slovenia * m                               a Armenia
5                  Hungary
0
0          1           2          3          4          5           6
Administrative corruption index


XIX
The typology is not intended to define absolute and unambiguous divisions among
countries. Rather, it is presented as a heuristic device to highlight analytically and empirically the
differences in patterns of corruption across countries. Like all aggregate indices, the measures of
administrative corruption and state capture mask important variation across institutions within
the state and across actors engaged in these activities. As a result, the typology cannot replace the
critical role that individual country studies should play in identifying the extent and nature of the
corruption problem and in further unbundling the forms of corruption identified in the report.
Indeed, the typology should be seen more as a guide for self-assessment by countries as to the
nature of the corruption problems they face, than as a definitive categorization of countries on
these complex dimensions of corruption.
The typology can be divided into four spheres determined by the relative levels of state
capture and administrative corruption:
*  Countries within the medium-medium category have been able to contain both types of
corruption to more manageable levels, though serious challenges remain.
*  In the medium-high category are countries where the problem of administrative corruption
remains the central problem, while the state has been less subject to capture by the private
sector than other transition countries.
*  The high-medium category includes countries that have been able to contain the level of
administrative corruption relative to other transition countries, but nevertheless have done so
in a context of high state capture.
*  In the high-high category, a serious problem of administrative corruption-and hence, weak
state capacity-is nested in a state highly subject to capture.
The typology presents a static picture of the pattern of corruption across transition
countries at a single point in time, but it must be recognized that the pattern of corruption is
much more dynamic. Indeed, in designing an effective anticorruption strategy, it might be more
useful to know in which direction a country is moving within the typology rather than its position
at any given time. The typology does not set out a simple linear path of development. Rather,
countries can zigzag, progressing on one dimension of corruption, falling behind on the other, or
moving ahead on both fronts simultaneously. Recognizing these different patterns and analyzing
alternative evolutionary paths across these patterns could provide a stronger foundation for
devising more appropriate and finely tuned anticorruption strategies in different contexts.
The Origins of Corruption in Transition
The simultaneous transition processes of building new political and economic institutions
in the midst of a massive redistribution of state assets have created fertile ground for state
capture and administrative corruption. Yet, there is tremendous variation across countries in
both areas. An effective strategy for anticorruption must be based on an understanding of the
root causes of different forms of corruption and their variation. Without it, policymakers run the
risk of treating the symptoms without remedying the underlying conditions.
While it is impossible to disentangle with much certainty the complex interactions and
lines of causality that determine variations in institutional outcomes across countries at any given
point in time, it is possible to trace different paths of development over time. Countries entered


XX
the transition with very different initial conditions, i.e., levels of development, political and
economic legacies, and natural and social endowments. These initial conditions influenced the
early choices about the structure of political institutions and the nature of economic policies-
choices that in turn affected alternative transition paths. The extent of state capture and
administrative corruption is both a product of such transition paths and a driving force for further
developments. However, the considerable variation in these forms of corruption both across and
within geographic regions suggests the critical importance of political leadership, policy
innovation and strategic vision in altering the course of transition.
As state capture is, by definition, a function of the concentration of economic power,
differences in the structure of the
economy across countries should have          Figure 5. Resource Endowments and
an impact on the potential for capture.                 Corruption
In countries where national wealth is
highly concentrated in a few    key
productive assets, there are significant              301
risks that powerful interests will seek to
Share of countries
gain control over them and invest some     Incategorythatare20.
portion of their "windfall gains" to
capture state institutions in an effort to            10*
sustain and strengthen their positions.
Thus, countries richly endowed with
natural resources (e.g., Azerbaijan,                                medium
Russia, Kazakhstan, and Turkmenistan)                     State Capture
or well placed to serve as transit routes for the distribution of these resources (e.g., Latvia) are
prime candidates for state capture. Figure 5 makes clear that the level of state capture is higher in
countries with greater endowments of natural resources.
The transition countries can be distinguished not only by their resource endowments but
by the institutional legacies inherited from their pre-communist pasts. Some countries entered the
transition with more highly developed systems of public administration and better trained public
officials. For instance, countries with longer experience of sovereignty and closer links to
European standards of civil service and judicial administration, as depicted in Figure 6, entered
the transition with substantial advantages. These countries were also more likely to have adopted
variants of market socialism during the communist period, which provided for a smaller role of
the state in the economy and greater
development of market institutions.
Figure 6. Statehood and Corruption
With a stronger legacy of
sovereignty, these countries tended          70 r s t t io   t
to develop more extensive social
networks  for   collective  action bu
against the communist system when
officials For instnce, counrieswithlongr epeariec  ofsvrinyadflsrlnst
opportunities arose. As a result, the  sthteo easor  w
collapse of communism   in these      entury         4,
countries (for example in Hungary,
Poland, and the Baltic states) was
30                   Administrative
meim Shigh               Corruption
high
State Capture


Xxi
accompanied by social movements for change that generated a sharp break with previous
political leaders and elites. This promoted greater political competition, the entry of new elites,
and higher levels of accountability of these political leaders to the newly mobilized public.
In countries whose beneficial institutional legacies pushed them toward a transition path
marked by a sharp break with the previous system, greater state capacity, and a civil society
strong enough to promote change and accountability, we find a level and pace of political and
economic reforms that have contained the worst excesses of corruption relative to other
transition countries. State capture has been limited by stronger political competition and a civil
society better able to constrain the power of concentrated economic interests. Administrative
corruption has been limited by such a higher level of accountability, as well as by the more
developed public institutions associated with a more advantageous historical legacy.
In contrast, countries that started the transition with greater continuity between the old
and new systems, less developed public administrations, and weaker civil societies tended to
adopt a path of partial political and economic reforms that intensified a wide range of rent-
generating economic distortions and placed only minimal mechanisms for accountability on
public officials. This has proven to be fertile ground for the growth of state capture and
administrative corruption.
A Multi-pronged Strategy for Combating Corruption
The standard advice for combating corruption has traditionally focused on measures to
address administrative corruption by reforming public administration and public finance
management. But with the increasing recognition that the roots of corruption extend far beyond
weaknesses in the capacity of government, the repertoire has been gradually expanding to target
broader structural relationships, including the internal organization of the political system,
relationships among core state institutions, the interactions between the state and firms, and the
relationship between the state and civil society. An outline of this broader agenda is presented in
Figure 7. Each block of this comprehensive set of instruments is designed to target a structural
relationship that contributes to the level and profile of corruption.


xxii
Figure 7. Multi-pronged Strategy: Addressing State Capture and Administrative Corruption
Institutional Restraints:            Political Accountability:
* Independent and effective judiciary  * Political competition, credible political parties
* Legislative oversight              * Transparency in party financing
* Independent prosecution, enforcement  * Disclosure of parliamentary votes
* Asset declaration, conflict of interest rules
Competitive Private Sector:
Civil Society Participation:                       Economic policy reform
"*Freedom of*information                           Competitive restructuring of monopolies
* Public hearings of draft laws                    Regulatory simplification for entry
" Role for medialNGOs                              Transparency in corporate governance
*Collective business associations
Public Sector Management:
* Meritocratic civil service with monetized, adequate pay
* Budget management (coverage, treasury, procurement, audit)
* Tax and customs
* Sectoral service delivery (health, education, energy)
* Decentralization with accountability
Increasing political accountability: Political accountability refers to the constraints
placed on the behavior of politicians and public officials by organizations and constituencies
having the power to apply sanctions to them. As political accountability increases, the costs to
politicians of making decisions that benefit their private interests at the expense of the broader
public interest also increase. Two of the key instruments for strengthening political
accountability are: (i) increasing the transparency of decisions made by public officials and (ii)
increasing competition through organizations that provide broad constituencies with vehicles,
such as mass-based political parties, for expressing their collective demands. Transparency can
be fostered by a number of measures such as requiring public officials to disclose their income
and assets to reveal conflict of interest. Such laws feature in many countries like Latvia, where
the law penalizes illicit enrichment of officials who cannot justify possession of assets in excess
of their normal source of income, and Lithuania, where the asset declaration law has been
successfully used to remove corrupt officials from office.
Strengthening institutional restraints within the state. The institutional design of the state
can be an important mechanism in checking corruption, in particular, the effective separation of
powers among state entities with each operating as a check on the abuse of power by the others.
Strengthening and raising the credibility of the judicial system by enhancing the independence
and accountability of judges and matching functions with budget and capacity are particularly
important. To hold governments accountable, parliaments need public accounts and audit
committees, powers to require disclosure of government documents, and the capacity to
implement credible sanctions. Audit organizations also play an important role. A good-but
rare-example is Poland's Supreme Audit Chamber, which investigates and publishes reports on


xxiii
abuses in procurement, management of public assets, and other diversions of public funds. A
condition for the effectiveness of these institutions is the establishment of a core of strong,
credible, and independent professionals in the judicial, prosecutorial, and police arms of the
state.
Strengthening civil society participation: As stakeholders in the quality of governance
and as intermediaries for communication between the populace and the institutions of state, the
organizations that comprise civil society can be essential in constraining corruption. Recently,
there has been an emergence of greater civil society activism regarding corruption throughout the
region, focused especially on: creating public awareness about corruption and the need to control
it, formulating action plans to fight corruption, and monitoring government behavior. Civil
society has proven to be most effective when the government treats it as a participatory ally. The
experience of the Slovak Republic provides a good example: the national chapter of
Transparency International was entrusted with the first draft of the National Program for the
Fight Against Corruption and has regularly been invited to monitor procurements and other state
decisions.
Fostering an independent media: Free and open media help check the level of corruption
by uncovering and shedding light on abuses. Yet the promise of a free press has not yet been
fully realized in many transition countries. Weakening the media's potentially powerful
contribution to limiting corruption are: lingering state controls, conflicts of interest generated by
ownership arrangements, and corruption in the media itself. A policy of openness, formalized in
laws guaranteeing free access to information, strengthens tools for oversight and enlists the
media as an ally in controlling corruption.
Creating a competitive private sector: A state is most vulnerable to capture when
economic power is concentrated in a few firms or industries and when competing economic
interests lack viable access to the policymaking process. The ability of powerful economic
interests to capture the state can be checked by reducing the benefits to these firms from capture.
This can be achieved in part by deepening price and trade liberalization, increasing transparency
in the ownership structure and operations of firms, and introducing greater competition in
concentrated sectors by lowering barriers to entry and requiring competitive restructuring.
Reducing the ability of the state to extort bribes from the private sector requires deregulation.
Hungary, Poland, and the Czech Republic have taken this approach, emphasizing the elimination
of unnecessary licenses and rules and creating effective institutions for regulation. Both the
potential for capture and the risk of administrative corruption can be diminished by strengthening
instruments of voice, such as business associations, trade unions, and other collective actors for
broad-based economic and social interests. A number of international conventions that aim to
intensify the detection and punishment of transnational corruption, such as money laundering,
are available for signature.
Reforming public sector management: While strengthening mechanisms of external
accountability is important, it is also essential to strengthen the internal management of public
resources and administration to reduce opportunities and incentives for corruption. This requires
instilling meritocracy and adequate pay in public administration. Poland, Latvia, and Kazakhstan
have made strides in this direction, initiating a meritocratic system for appointment, promotion,
and performance evaluation. Moreover, changes in governance structures are needed to separate


Xxiv
regulatory and economic functions and to rein in agencies outside policy and financial control.
Transparency and accountability in fiscal management need to be enhanced by ensuring full
budget coverage and control, instituting functioning budget planning and execution systems, and
promoting the establishment of robust accounting and auditing. Opportunities for corruption in
sectoral service delivery need to be reduced through policy reforms and greater public oversight.
Finally, decentralization efforts need to focus on improving accountability and creating local
capacity for financial management early in the process of decentralization.
Designing Effective Anticorruption Strategies
Taken together, the five building blocks of a multi-pronged approach to combating
corruption might appear overwhelming, as they entail significant changes in the structure of
existing economic and political institutions, in the nexus of relationships within the state and
between state and society, and in the existing policy practices of governments. No government
has the capacity to pursue simultaneous reforms in all of these areas. To be effective, a multi-
pronged approach requires some guidelines for the selection and sequencing of reform priorities
tailored to the particular contours of the corruption problem in each country. This report draws
lessons from the typology to provide such guidelines.
Medium State Capture/Medium Administrative Corruption
Though the countries within this sphere exhibit lower levels of state capture and
administrative corruption relative to other transition economies, the challenges are still
significant. The political consequences of corruption are not necessarily correlated with the level
of corruption. Where political competition is robust and the electorate increasingly sophisticated,
complacency in the face of state capture and administrative corruption has the potential to
generate even greater political instability than it does in less advanced, but more corrupt political
systems.
Medium / Medium
Medium State Capture I Medium Administrative Corruption
Key Focus: Capitalizing on favorable conditions for strengthening
political accountability and transparency through further institutional
reforms
Challenges                         Priorities
*  Risk of complacency and         *   Promote further reforms in civil
backstepping                       service, public finance,
*  Close ties between economic        procurement, and judiciary
interests and political institutions  *  Introduce greater transparency into
*  Cronyism and conflict of interest in  political financing
public sector appointments      *  Develop strong partnerships with
civil society


xxv
What distinguishes these countries is not the modesty of the corruption challenges they
face, but the level of development of many of the key institutions and tools necessary to confront
them. These include civil society institutions that are beginning to grow in strength, a vigorous
independent media, an evolving system of institutional restraints within the state, functioning
institutions of public administration, and some foundation for the rule of law. A good example is
Poland, which has cross-party leadership, a vibrant media, and strong sources of advocacy and
analysis from NGOs and academic institutes. Such institutions are necessary for building and
empowering the domestic constituencies that generate sustained demand for combating
corruption.
Most countries in this group continue to lack one or more of the following essential
ingredients for an effective anticorruption strategy: i) political will; ii) collective action; and iii)
relevant technical knowledge and practical experience.
Reducing state capture requires a strategy that goes beyond the classic technocratic
approach. While relatively robust economic and political competition place some constraints on
state capture in these countries, there are still vast areas open to abuse, in particular political
party financing and conflicts of interest. Clear guidelines on financing political parties and
mechanisms to enhance transparency are absolutely essential. The introduction-and effective
implementation-of clear and comprehensive conflict of interest legislation could also have a
powerful impact. Both areas require stronger verification and audit powers and further judicial
and prosecutorial training and reform, worthy areas of institutional development in their own
right. Strengthening enforcement mechanisms is also a feasible strategy in countries with a
stronger framework for the rule of law.
At the same time, a high priority should be given to the implementation of best-practice
technocratic reforms in the civil service, financial management and procurement, with the aim of
increasing transparency, accountability, and efficiency in public administration and public
finance. Committed political leadership of these reforms is essential.
Despite their many advantages, failure to act decisively to control state capture in these
countries could run the risk of slipping backwards within the framework of the typology. The
most likely path of regression in countries with reasonably stronger traditions of public
administration is toward higher levels of state capture. As these economies grow, the capacity of
powerful economic interests to influence fast-developing legal, legislative, and regulatory
frameworks could outpace the constraints imposed by competing interest groups and civil
society. The risk increases in those countries where a major agenda of structural reforms remains
to be completed.
Medium State Capture/High Administrative Corruption
The main feature of most of the countries falling into this category-Albania provides an
example-is the weak capacity of existing state institutions, both in terms of the provision of
basic public goods and regulatory functions and the existing mechanisms of accountability


xxvi
and control within the state apparatus. Administrative corruption thrives in such an environment
and often reaches the highest levels of the political system. State capture by firms is lower than
in other transition countries. However, this does not appear to be due to any greater degree of
political constraints on state actors, but rather to a less concentrated and less developed economic
structure or to the overall lack of state capacity to intervene in the economy. There are also other
forms of state capture, such as by public officials themselves or by specialized state sectors (e.g.,
the military) that may be relevant in individual cases, but are not measured in the BEEPS survey.
Medium / High
Medium State Capture / High Administrative Corruption
Key Focus: Enhancing state capacity to improve the provision of basic
public goods.
Challenges                        Piorities
*  Highly underdeveloped public   * Build the capacity of public
administration                    administration
*  Lack of control and accountability  a Develop instruments for financial
within the state                  management
*  Nascent civil society          * Encourage civil society
development
In such countries, anticorruption efforts should be synonymous with fundamental state-
building. This entails, first and foremost, developing the capacity of the state to deliver basic
public goods, such as public order and stability, health care and social protection, and simple
systems of public revenue management. Enhancing the capacity of basic institutions of public
administration and the civil service is necessary, but this should be combined with liberalizing
measures to reduce bureaucratic discretion in the economy.
Civil society in these countries may be particularly weak; clans or other informal ties can
lead to social fragmentation in some cases. Consequently, there are unlikely to be strong social
constituencies to demand and sustain an anticorruption program. Public education and awareness
are particularly critical elements of any anticorruption strategy in these countries, as the
constituencies for reform within civil society are unlikely to have the capacity to sustain the
demand side for anticorruption activities.
Perhaps one of the most serious problems in this group of countries is the looming threat
of higher levels of state capture. As the private economy develops and gathers strength, there


Xxvii
will be strong incentives for these actors to engage in state capture. Paradoxically, stability could
carry greater risks of state capture by private firms, as the influence of other important
constituencies within the state begins to subside.
High State Capture/Medium Administrative Corruption
Countries with high levels of state capture alongside medium levels of administrative
corruption generally benefit from a historical legacy of the rule of law and well-developed public
administrations associated with previous, pre-communist regimes. However, their problems with
state capture can be rooted in either high concentrations of economic power in key industrial
sectors or weakly accountable political regimes built around populist or nationalist politicians
having close ties to powerful enterprises. An example of the first problem-high concentration
of economic power-is Latvia, where political parties are closely aligned with economic
interests, and its geographical location on east-west trade and energy transit routes exposes it to
strong corruption pressure. The second problem-weakly accountable political regimes-was
the case with the first governments after independence in Croatia and the Slovak Republic. State
capture can be seen as repressing the advantages that these countries have in terms of the
capacity of the state and the strength of public administration.
High / Medium
High State Capture / Medium Administrative Corruption
high  medium uedium  ud mnistrative
corruption
state capture
Key Focus:Enhancing political accountability and promoting new entry
to take maximum advantage of a stronger legacy of state
capacity.
Challenges                            Priorities
*  High concentration of power        *  Broaden formal channels of access to
by vested interests                   the state
*  Weak structures for monitoring     *  Deconcentrate economic power
and accountability                    through competition and entry
*  Powerful groups block further      *  Enhance oversight through
reforms to preserve their             participatory strategies
advantages
The major obstacles to further progress on structural reform lie less in the weak capacity
of state institutions than in the power of vested economic interests and the private interests of
powerful politicians. Though basic political institutions and civil society are much more
developed in this group compared with the previous one, mechanisms of political accountability


Xxvii
tend to be attenuated due, in some instances, to the semi-authoritarian nature of the political
regimes. Conflicts of interest abound as political strongmen tend to equate their private well-
being with the country's well-being. Favored firms develop close ties to political leaders and
their parties, often bluffing the boundaries between the party and the firm.
Though technocratic reforms might be useful as entry points into anticorruption work, a
credible reform program should be designed to broaden formal channels of political access and
to increase the accountability of public officials to a wider range of constituencies. Efforts to
promote collective action among anticorruption constituencies and competing interest groups
should play an important role in an anticorruption strategy. Encouraging the development of
institutional mechanisms of political oversight and promoting transparency in party financing
could also have a positive impact. In sequencing an anticorruption strategy, the early promotion
of political reforms and partnerships with civil society has the potential to achieve a considerable
impact.
It is in this group of countries that a democratic change of regime can offer the greatest
opportunities for implementing a comprehensive anticorruption strategy. Regime change is
sometimes accompanied by a resurgence of political competition, a strengthening of political
parties, and a rejuvenation of civil society that can increase accountability pressures on the new
leadership. This could create a valuable window of opportunity to promote an anticorruption
strategy that strikes at the root causes of the problem. Such a window of opportunity is evident
in the Slovak Republic, where the coalition elected in 1998 has put anticorruption high on the
agenda and there are some indications that perceived levels of corruption, though still high, have
fallen.
Failure to constrain and reduce state capture could lead to further regression and the
erosion of existing state capacity that keeps administrative corruption in check. The prolonged
use of corrupt incentives to influence policymakers and administrators leads to diminishing
confidence in public servants and state institutions. Informal networks are strengthened to gain
access to privilege. Growing informality weakens revenue collection, limiting the resources
available to maintain a professional civil service and support public finances.
High State Capture/High Administrative Corruption
Finally, there are countries where state institutions with weak administrative capacity
coexist with a high concentration of vested interests and a state highly susceptible to capture. In
these cases, the challenge of combating corruption is particularly difficult. Powerful private
interests have the capacity to block institutional reforms that would limit their capacity to extract
rents from the state and eliminate market distortions that work to their advantage. The
government lacks sufficient mechanisms of control and accountability throughout the state
bureaucracy to implement institutional and policy reforms. Nascent civil societies and
intermediary associations do not have sufficient power to counterbalance the weight of
concentrated vested interests. This is the most difficult environment in which to design an
effective anticorruption program.


XXiX
High / High
High State Capture / High Administrative Corruption
Key Focus: Breaking the hold of vested interests on the policymaking
process
Challenges                          Prorities
*  Highly concentrated economic     0 Deconcentrate economic interests
interests                           through restructuring, competition
*  Limited implementation capacity of  and enhanced entry
government                       *  Build accountability and oversight
*  Weak anticorruption constituencies  mechanisms
*  Restricted channels of access       Promote collective action among
for countervailing interests        countervailing interests
Stand-alone technocratic reforms
will have limited impact
Stand-alone efforts to tackle administrative corruption through technocratic reforms in
public administration and public finance are likely to have limited impact. The institutional
context is as yet too weak to deliver the minimum necessary underpinnings for reform. Given the
low level of organization of civil society and constricted formal channels of interest
intermediation for countervailing social groups, such efforts are unlikely to prove sustainable
over time.
Targeting state capture requires measures on two  fronts: (i) decreasing the gains to
captor" firms deriving from state capture and (ii) increasing the costs to politicians of state
capture. Decreasing the gains to captors entails deconcentrating vested economic interests
through competitive restructuring of monopolies, reducing barriers to entry, and increasing
transparency in corporate governance. Increasing the costs to politicians requires efforts to foster
collective action among potential countervailing interests, such as "second-tier" companies and
small- and medium-sized enterprises, to obtain political access.  This could entail the
development of business and trade associations and formal lobby groups to increase the range of
interests with access to government, to foster competition in an effort to reduce the concentration
of existing rent streams, and to strengthen formal and transparent channels of political influence.
The goal is to promote a greater number and diversity of economic actors competing through
more transparent and open conduits of political access for a limited pool of rents.


XXX
On the costs to politicians, the weak organization of civil society and low level of
accountability and transparency within the state suggest that efforts should begin with building
credible constituencies in and outside the government to bring the very issue of corruption to the
forefront. Without such constituencies, serious institutional reforms to enhance accountability
and to strengthen civil society participation are unlikely to have a sustainable impact.
Expectations should not be unrealistic and the time horizon of reform should be
considered quite long. Though occasional windows of opportunity for reform might arise, it is
crucial to recognize that the extent of state capture, the concentration of economic interests, and
the institutional weaknesses of the state will serve as powerful constraints on the effectiveness
and sustainability of reforms introduced through such windows. Anticorruption assistance
programs should be designed around achievable "litmus tests" to gauge the government's
commitment to reform and to recognize the limitations in such environments. Efforts to build up
demonstration effects through intensive work with carefully selected organizations, sectors, or
regional authorities might provide a method of entry into broader anticorruption work.
Operationalizing an Anticorruption Strategy
Though the typology provides a framework for tailoring individual anticorruption
strategies in different contexts, there are a number of cross-cutting principles that can be
essential in operationalizing an effective strategy. They provide a framework for gaining a
foothold to begin anticorruption work, building credibility behind an anticorruption strategy, and
enhancing the sustainability of that strategy over time.
Credible political leadership: A serious anticorruption program cannot be imposed from
the outside, but requires committed leadership from within, ideally from the highest levels of the
state. While pressure for reform can come from below-indeed, this can effectively generate a
needed social consensus-any effective program must be supported from the top.
Diagnosing the nature and extent of the problem in each case: Implementing surveys,
running workshops, and developing a dialogue with institutions of civil society on corruption are
all critical for gaining country-specific knowledge beyond the narrow limits of the typology. The
process can also play a major role in building anticorruption constituencies.
Assessing the environment: The relevance and feasibility of specific reform instruments
is closely linked to the way in which power is exercised, the level of informality in the society,
and the extent to which people feel trust in their institutions and in each other. These factors
create an enabling or constraining environment, together with incentives and disincentives for
change, that must be taken into account in the choice and sequencing of instruments if
anticorruption strategies are to be realistic and effective.
Finding appropriate entry points: It is critical to begin at a point where the goals are
feasible and tangible results can be realized within a time frame that builds support for further
reforms. Small gains can provide essential levers to sway public and official opinion.
Maximizing leverage: Efforts should be made to design "win-win" anticorruption
strategies that promote the interests and reputations of major politicians and businesspeople


Xxxi
while delivering positive externalities such as enhancing economic growth, strengthening
governance, or reducing poverty and inequality.
Conclusion
The challenge ahead for transition countries is to strengthen the commitment to tackle
corruption. The task will not be easy. The status quo often benefits powerful interests, state
capture poses formidable challenges, and the political economy of anticorruption initiatives has
proven complex and difficult. The roots of these problems reach deep into historical legacies,
economic structures, and transition paths. While valuable windows of opportunity may arise in
specific countries, it remains important to manage expectations and underscore the long-term
nature of reform, while still taking decisive actions and building credibility.
Reform and progress are possible and the costs of doing nothing are extremely high.
Unbundling corruption and tailoring reform strategies to target the specific profile of the problem
in different countries provide important insights into the design of effective anticorruption
strategies. After ten years of transition, the building blocks of reform are now better known, but
the challenge remains to prioritize and sequence these reforms in a manner that can build
credible support for a sustainable process of change. By analyzing the factors underlying the
persistence of corruption in different contexts, this report provides a framework for meeting this
challenge.



Chapter 1: The Level and Pattern of Corruption in the Transition Countries
In recent years, a consensus has emerged across the globe on the high costs of corruption
for economic, political, and social development. There has also been broad agreement on an
approach to combating corruption that focuses on limiting the discretionary powers of state
officials to intervene in the economy.' As a result, the fight against corruption in the transition
countries has been incorporated into a wider reform agenda combining liberalization and
privatization to roll back the state and governance reforms to promote greater transparency and
accountability in the state's legal and regulatory framework. However, the experience of the first
decade of transition in reducing corruption has been decidedly mixed. Efforts to reform basic
state institutions have generally had limited impact. Anticorruption campaigns have been
hijacked for narrow political advantage. Governance reforms have frequently been blocked by
powerful vested interests. The political will to implement and sustain structural reforms has often
been lacking. This experience suggests that, although we may know a great deal about the causes
and consequences of corruption, we know much less about the factors underlying the persistence
of corruption.
Part of the problem comes from unrealistic expectations about the time necessary to
address the fundamental roots of corruption, even in the fast-paced environment of the transition.
But an important part of the problem also lies in the tendency to focus exclusively on the state
and, in so doing, to limit our anticorruption strategy to standardized technical solutions. This has
led to an incomplete and overly uniform approach to combating corruption that does not take
into account important differences among countries in the capacity of the state, the power and
concentration of economic interests, and the channels of accountability between the state and
civil society-all of which are crucial determinants of the pattern and persistence of corruption
across countries.
This report attempts to develop a more nuanced approach to corruption. It begins by
unbundling the problem to recognize that different dimensions of corruption might have unique
origins and consequences.2 On this basis, a typology of corruption is developed to distinguish
among different patterns of the problem across the transition countries. Specific policy
recommendations are tailored to these distinct patterns, drawing from a common set of
institutional and policy reforms, and with emphasis on how to target anticorruption efforts, how
to sequence reforms, and how to calibrate realistic expectations in different contexts.
The typology is based on the distinction between two types of corruption-state capture
and administrative corruption. State capture refers to the actions of individuals, groups, or firms
in both the public and private sectors to influence the formation of laws, regulations, decrees, and
other government policies (i.e., the basic rules of the game) to their own advantage by means of
the illicit and non-transparent provision private benefits to public officials (see Box 1.1 for a
further discussion of this concept). For example, an influential "oligarch" at the head of a
powerful financial-industrial group could buy off legislators to erect barriers to entry in a
particular sector. Alternatively, the state can be captured to serve the private interests of a
political leader who shapes the framework of reforms to ensure his own private control over key
resources.


2
There are many different forms of state capture. Distinctions can be drawn between the
types of institutions that are captured-the legislature, the executive, the judiciary, or regulatory
agencies. Further distinctions can be made on the basis of who does the capturing-private firms,
political leaders, or narrow interest groups. One could even distinguish between the nature of the
benefits provided to public officials in exchange for capture-direct bribes, illicit equity stakes,
informal control rights. Yet all forms of state capture are directed toward extracting rents from
the state for a narrow range of individuals, firms, or sectors through distorting the basic legal and
regulatory framework, with potentially enormous losses for the society at large. They thrive
where economic power is highly concentrated, countervailing social interests are weak, and the
formal channels of political influence and interest intermediation are underdeveloped.
While state capture encodes advantages for particular individuals or groups in the basic
legal or regulatory framework, administrative corruption refers to the intentional imposition of
distortions in the prescribed implementation of existing laws, rules, and regulations to provide
advantages to either state or non-state actors as a result of the illicit and non-transparent
provision of private gains to public officials. The classic example of administrative corruption is
that of a hapless shop owner forced to pay bribes to a seemingly endless stream of official
inspectors to overlook minor (or possibly major) infractions of existing regulations. Beyond such
forms of extortion, administrative corruption also includes such familiar examples of "grease
payments" as bribes to gain licenses, to smooth customs procedures, to win public procurement
contracts, or to be given priority in the provision of a variety of other government services.
Finally, state officials can simply misdirect public funds under their control for their own or their
family's direct financial benefit. At the root of this form of corruption is discretion on the part of
public officials to grant selective exemptions, to prioritize the delivery of public services, or to
discriminate in the application of rules and regulations.
Both state capture and administrative corruption can cut across different levels of
government. Both can be initiated by state officials, private businessmen, or other non-state
actors. The key difference is neither who extracts the rents nor how important is the official who
receives the bribe, but rather the nature of the political relationship underlying each form of
corruption. In capturing the state, actors prejudice the rules to their own narrow advantage,
which subsequently constrains the actions of others in the economy. Through administrative
corruption, actors obtain individualized exceptions to or favorable application of those rules. The
difference lies in how deep the corrupt transaction reaches into the operations and functions of
the state and the extent to which the advantages of the corrupt transaction are institutionalized
into the basic rules of the game. Though there will be many specific cases where the borderline
dividing these two forms of corruption might be difficult to draw with a high degree of certainty,
the distinction nevertheless has important analytical and practical implications for the potential
effectiveness of different anticorruption strategies.


3
Box 1.1: The Concept of State Capture
The definition of state capture used in this report is derived from the concept of regulatory capture, already well
established in the economics literature.4 State regulatory agencies are said to be "captured" when they regulate
businesses in accordance with the private interests of the regulated as opposed to the public interest for which they
were established. Though regulatory capture can occur through the provision of private gains, both direct and
indirect, by regulated businesses to state officials, it is not limited to influence through corrupt means.5
State capture is a 6roader concept in that it encompasses the formation of laws, rules, and decrees by a wider range
of state institutions, including the executive, ministries and state agencies, legislature, and the judiciary. At the same
time, state capture has a narrower definition in that it focuses exclusively on illicit, illegitimate and non-transparent
forms of influence.
Who can capture the state? Often, the "captors" are individuals, groups, or firms from the private sector seeking
rents or other advantages from the state. Yet any actors with access to public officials and the capacity to provide
private benefits to these officials in order to obtain advantages in the governing process can be seen as potential
captors. Indeed, public officials themselves can capture the state if they abuse their authority to shape institutions
and laws primarily to further their own private financial interests at the expense of the broader public interest,
though identifying and indeed measuring such conflicts of interest are nearly impossible in the context of the
transition.
The influence of private interests on the decisions of the state is a normal feature of all political systems. What
separates state capture as a form of corruption from conventional forms of political influence, such as lobbying, are
the mechanisms by which the private interests interact with the state. State capture occurs through the illicit
provision of private gains to public officials via informal, nontransparent, and highly preferential channels of access.
It can also occur through unclear boundaries between the political and business interests of state officials, which has
been a particularly prominent characteristic of many transition countries. In all its forms, state capture tends to
subvert, or even replace, legitimate and transparent channels of political influence and interest intermediation,
reducing the access of competing groups and interests to state officials.
Different forms of state capture as distinguished by different types of captors (e.g., private firms, politicians, ethnic
groups, the military) and different state institutions involved (e.g., the executive branch, the legislature, the
judiciary, or regulatory bodies) will undoubtedly have their own unique dynamics and consequences. Therefore,
state capture itself could be unbundled to reveal a wide range of different relationships.
Reducing state capture does not entail eliminating private sector influence on the formation of policies, rules, and
laws by the state. Indeed, such influence can be an important factor pushing forward both economic and political
reform. Nor will it be resolved by legalizing private payments to public officials. Rather, reducing state capture
involves shifting private sector influence from illicit, nontransparent, and highly preferential channels of access
toward legitimate, transparent, and competitive forms of interest intermediation. It also involves developing clearer
boundaries between the political and business roles of state officials in order to prevent conflicts of interest.
Though the report highlights the problem of state capture in transition countries, it is by no means confined to the
transition and continues to be a serious problem in most societies. Yet the problem in many transition countries is
exacerbated by the high concentration of economic power, the poorly developed formal channels of political
influence and interest intermediation, and the weak organization of countervailing interests both from the economy
and civil society.


4
In analyzing different forms of corruption, this report places primary emphasis on the
interaction between the state and the private sector. Of course, this dimension represents only
one subset of corruption. Corrupt transactions can occur entirely within the state, for example
when politicians bribe bureaucrats. The misuse of public authority for private gain need not
require the participation of private sector actors.6 At the same time, corruption within the private
sector itself can be an important dimension of the problem. Asset-stripping, abuse of minority
shareholder rights, and bribery to obtain private services in restricted or distorted markets are all
forms of corruption that do not directly involve public officials (though their indirect complicity
is often an important factor). While these forms of "public-to-public" and "private-to-private"
corruption will be discussed in the report, the focus on the interaction between the state and the
private sector is rooted in the particular nature of the process of transition, characterized by the
simultaneous building of the state and the market economy.
Faced with the concurrent challenges of defining the basic rules of the game, redistributing
the bulk of state assets, forming new political structures, and establishing the key institutions of a
market economy, most transition countries have been unable to define clear boundaries and
effective forms of intermediation between the state and the private sector. The fusion of the party
and the command economy that characterized the previous communist system has been replaced
in many countries of the region by a new fusion of the transitional state and the now largely
private economy. Political leaders are closely tied to business empires. Political parties are thinly
veiled fronts for powerful firms. The media trumpet the rival interests of oligarchs to explain key
policy decisions of the state. Though such phenomena are hardly unique to transition, the
simultaneity of the political and economic transformations in a highly truncated time frame has
exacerbated the opportunities for state capture in the transition countries.
Yet despite its importance, the lack of reliable empirical data on state capture has
prevented serious empirical investigation. This report presents and analyses the first systematic
data on state capture collected in the transition economies, along with new efforts to quantify
the level and impact of administrative corruption. The data come from the 1999 Business
Environment and Enterprise Performance Survey (BEEPS), a firm-level survey commissioned
jointly by the World Bank and the European Bank for Reconstruction and Development (EBRD)
to assess obstacles in the business environment across the transition economies (see Box 1.2 for a
description of the survey). Based on more than 3,000 interviews with the owners and senior
managers of firms in 22 countries across the region, the BEEPS data provide an opportunity to
investigate state capture and administrative corruption from the point of view of some of those
most directly affected. While the BEEPS data spotlight the relations between the state and firms,
data from a wealth of audit reports, empirical studies, and detailed diagnostic surveys in selected
transition countries are also presented to provide a broader picture of other forms of corruption
from the perspectives of households and state officials. These surveys constitute a major step
forward in understanding the depth and contours of the problem of corruption within and across
countries.


5
Box 1.2: The Business Environment and Enterprise Performance Survey
The BEEPS survey was conducted on the basis of face-to-face interviews with firm managers or owners in site visits
during the period June through August 1999 in the following countries: Albania, Armenia, Azerbaijan, Belarus,
Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Kyrgyz Republic, Latvia, Lithuania,
Moldova, Poland, Romania, the Russian Federation, Slovak Republic, Slovenia, Ukraine, and Uzbekistan. With the
exception of Albania and Latvia, the survey was conducted in all countries by local staff of an international survey
firm to ensure consistency of training and approach across countries.
In each country, between 125 and 150 firms were interviewed, with the exception of three countries where larger
samples were used: Poland (250), Russia (550), and Ukraine (250). The sample was structured to be fairly
representative of the domestic economies with specific quotas placed on size, sector, location, and export
orientation. The sample was heavily weighted toward privately owned firms, though there were quotas for state-
owned firms and firms with foreign ownership. However, no attempt was made to construct a representative sample
across these ownership strata and the quotas were designed only to ensure representation.
Attempts to compare levels of corruption across different countries are fraught with difficulties. Most existing cross-
country surveys of governance and corruption rely on the subjective views of outsiders, namely expert assessments,
country analysts, or foreign investors.8 The results of such surveys are thus highly subjective and estimated with a
large margin of error that inhibits cross-country comparisons.9 The BEEPS relies on the direct experience of firms
rather than external subjective comparisons across countries. Where possible, numerical cardinal estimates of
problems are used (such as share of annual revenue spent on bribes) to measure the extent of the problem, as well as
to gauge the specific costs and benefits to the firm associated with corruption. These estimates enable us to measure
the margin of error on many questions, which are reported in the form of error bars in the figures below.
As many of the forms of corruption examined in this report are illegal in most countries, firms must be expected to
be reluctant to admit that they engage in such activity. In implementing the survey, the problems associated with
collecting reliable data were kept constantly in mind, and every effort was made to assure respondents that their
answers would be treated confidentially. Questions were phrased indirectly about the corruption faced by "firms in
your line of business" and respondents were assured that responses would be aggregated and not attributable to
themselves or their firms. The survey questions examine corruption from a number of different angles, providing
consistency checks on each firm's responses. Moreover, tests were conducted to detect any systematic positive or
negative bias among the firms in any given country. The ranking of transition countries on the indices of
administrative corruption and state capture used in this report remain basically unchanged when individual firm
characteristics such as size, sector, and ownership are controlled for statistically.
Source: Hellman, Jones, Kaufmann, and Schankermann (2000).
The report is divided into six chapters. This chapter goes on to investigate the incidence
and pattern of corruption in the transition countries, developing a country typology of corruption
that frames the entire report. Chapter Two examines the consequences and costs of different
forms of corruption on economic performance, poverty and inequality, and the credibility of the
state. Chapter Three looks into the origins of these different patterns of corruption, tracing
alternative paths of transition and how they are shaped by initial conditions, institutional
structures, and policy choices. Chapters Four and Five present the policy recommendations for
combating corruption that have been derived from the analysis. The former sets out the building
blocks to design an anticorruption strategy, while the latter draws lessons for combining,
prioritizing, and sequencing these building blocks to address most effectively the particular
contours of the challenge of corruption in different countries. Chapter Six draws conclusions on
the basis of existing international experience.


6
The Extent of Corruption in the Transition Countries
According to most existing efforts to compare perceptions of the level of corruption across
countries, many of the transition economies-in particular in the CIS-are seen to have among
the highest corruption indicators of all the countries surveyed. According to a summary index
developed from a weighted average of 12 of the most widely known cross-country corruption
indices with data from 1996-1999, the level of corruption in the CIS countries is perceived to be
comparable with the levels in South Asia and Sub-Saharan Africa as depicted in Figure 1.1.10 In
contrast, corruption in Central and Eastern Europe and the Baltics is seen to be on par with Latin
America and the Middle East, though the level remains considerably higher than it is in the
Organisation for Economic Co-operation and Development (OECD) countries.
Figure 1.1. World-wide Perceptions of Corruption
0.8
0.6
X
.  0.4
0
0.2
OECD  Southeast Asia  Middle East  Central and  Latin America  Sub-Saharan  South Asia  CIS
and North  Eastern         Africa
Africa  Europe and
the Baltics
The thin line at the top of each bar represents the statistical margin of error (based on a single standard deviation)
calculated on the basis of the aggregated indicators. Source: Kaufmann, Kraay, and Zoido-Lobaton (1999a).
While such comparisons are a useful indicator of international perceptions of corruption,
they provide little assistance in developing effective anticorruption strategies. They tend to be
based on the perceptions of external observers and investors rather than those of nationals having
direct experience of corruption in these countries. They collapse many different forms of
corruption into a single scale without recognizing the diverse patterns of corruption that can be
found in many countries. They hide important variation in the nature and level of corruption
within regions in any individual country. Enhancing the measurement and analysis of this
variation can provide critical insights both into the nature of corruption and the development of
strategies to combat the problem.


7
Unbundling Corruption in Transition
The BEEPS survey unbundles corruption to examine state capture and administrative
corruption separately to provide an empirical foundation for a more complex analysis of the
pattern of corruption in each country. However, the BEEPS data do not provide a comprehensive
measure of corruption in the transition countries. The survey focuses on the forms of corruption
in the enterprise sector that are subject to reliable measurement. As a result, the questions tend to
be biased toward those corrupt transactions in which direct payments are made to public officials
by enterprises. This leaves out a very wide range of corrupt transactions in which other forms of
benefits that are much more difficult to identify and measure are transferred to public officials,
for example, equity stakes in firms, gifts and services, or promises of future benefits. In
particular, the critical issue of conflicts of interest among public officials is not addressed in the
survey, as the boundaries between politics and business are inherently difficult to identify, much
less to measure across countries. It is likely that these different manifestations of corrupt
transactions are all highly correlated, though this remains an issue for further study."
In addition, the BEEPS survey provides a measure of corruption only from the perspective
of the firm in relation to its interactions with the state. Consequently, the data do not capture a
wide range of corrupt transactions that occur between public officials, between private sector
actors, or between individuals and the state. In some transition countries, pure public finance
corruption (i.e., theft or misappropriation of funds without the participation of firms) is likely to
be even more important than the public-private nexus. To supplement the BEEPS data, we rely
on surveys of households and public officials that were conducted in the context of "diagnostic
exercises" on corruption in selected countries of the region. Country examples are also used to
highlight forms of corruption that are particularly difficult to measure and compare across
countries.
Measuring Administrative Corruption
On the basis of the BEEPS data, indicators of the level of administrative corruption can be
constructed and compared across countries. As a proxy for a wide range of manifestations of
administrative corruption, firms were asked to estimate the share of their revenues that they
typically pay per annum in unofficial payments to public officials in order to influence the
implementation of state policies, regulations, and laws in each country.12 Figure 1.2 presents the
results aggregated by country.


8
Figure 1.2. Administrative Corruption (bribes as a share of annual revenues)
7
6
0
04
0- -
-~(                               CU     M C) 0 C  ) > C  C C
cclu  Ct           0 c BE EPS
S0       ~      N-                        0
N)                       E
C)~~                            ca>~ r
N                    NC                         0
The thin line at the top of each bar represents the statistical margin of error (based on a single standard deviation)
calculated for each country within the sample. Source: BEEPS.
Across the countries of the CIS, average payments for administrative corruption are
estimated by firms to be 3.7 percent of their annual revenues; the share falls to 2.2 percent of
revenues in Central and Eastern Europe.13 Yet measuring administrative corruption as a share of
firm revenues does not convey the full weight of the burden of this form of corruption. Though
data on profit margins for firms in transition economies are notoriously unreliable, given the
strong incentives to conceal profits and operate in the unofficial economy, the BEEPS survey
does provide a rough estimate of profit margins for firms that can be used to give a very crude
estimate of administrative corruption as a share of profits. Using the average reported profit
margin of 22 percent in the CIS countries and 13 percent in Central and Eastern Europe (CEE),
administrative corruption constitutes approximately 17 percent of profits across the region.
Though such estimates should be treated with considerable caution, they provide an indication of
the heavy burden of administrative corruption on firms in transition countries.
Beyond the clear differences between the CIS and CEE, the variation in administrative
corruption across countries within these regions is substantial. Some countries within CEE, such
as Albania and Romania, have reported levels of administrative corruption on par with the CIS
countries. Within the CIS, the highest levels of administrative corruption are reported in the
Caucasus, Kyrgyz Republic, and Ukraine. Other CIS countries fall within ranges more
comparable to countries in CEE.
The most commonly reported form of administrative corruption is unofficial payments to
obtain licenses and permits from the state. Other common forms of administrative corruption
include payments to deal with taxes and tax collection and to gain government contracts. A more
comprehensive picture of the extent of administrative corruption in transition countries can be
gained from household surveys, since individuals can also make unofficial payments to alter the


9
implementation of government policies. Household surveys in selected transition countries show
that corruption within the police force, particularly the traffic police, and the health services
accounts for approximately half of all bribe payments by households.14 Bribe payments
associated with the educational system, especially at higher levels of the system, are also
relatively common.
Measuring State Capture
Measuring the extent of state capture across countries presents a number of challenges.
First, relying on the BEEPS firm level data, we can only attempt to measure the extent to which
firms have managed to influence various state institutions in any given country. Other forms of
state capture that do not include private sector participation, such as capture by politicians for
their own private interests or by other non-state individuals and groups cannot be examined
through a firm level survey. As a result, measures based on the BEEPS data understate the
overall level of state capture in any country, while providing a more accurate measure of state
capture by private and public firms. This underestimation of overall state capture may be
particularly high in countries with kleptocratic political regimes, where institutions of the state
have been used to serve the interests of a particular leader and his broader circle (for further
discussion of the important issue of "who captures whom" see Box 1.3).
Box 1.3: Who Captures Whom?
State capture can clearly take many forms beyond the purchase of laws and decrees by private and public
enterprises. State officials may use their positions to capture enterprises, or may channel state funds for their
personal use in ways that do not involve other players at all. Yet the salient feature of these forms of capture is the
same as that of enterprise-state capture: the perversion of the rules of the game, through corruption, to the benefit of
the captors, rather than for society as a whole.
State capture can also be undertaken by actors within state institutions-the parliament, the executive, or the
judiciary. Ministers may shape laws, regulations, or tax policy to benefit themselves or their own financial interests.
In a number of countries ruling groups have disposed of assets for privatization through closed mechanisms
designed to preclude competition and to benefit themselves or their associates, enabling them to gain control of
substantial parts of the economy. In state-initiated capture, an explicit transaction need not take place, though there
may be an implicit contract or expectation of future rewards through quid pro quo asset transfers or employment in
advantageous posts. The defining characteristic is that representatives of state power, whether in the legislature,
executive, or judiciary, manipulate state powers for their own private gain.
The terrain for this kind of capture is larger when a substantial part of the economy remains in state hands.
Appointments to boards of state-owned enterprises can be a license to make money out of diversion of products, or
closed procurement, including setting up contracts with companies owned by the board members. In these cases, the
gains may be shared beyond the individuals who engineer them, with some part of the bribes and other advantages
being channeled back to the political party that ensured the appointment to the lucrative post.
One key source of the problem is that the concept of a conflict between public duties and private interests is either
poorly understood or inadequately respected. Safeguards against conflict of interest are key, and it is noteworthy that
many countries of the region have adopted legislation designed to prevent parliamentarians and other officials from
acting in a situation of conflict of interest. While few countries have implemented this legislation effectively, its
existence is a signal of aspirations to restrict state capture emanating from within the state.


10
Second, the dynamics of state capture may be very different depending on the extent and
nature of the private sector in any given country. Where the economy is still largely dominated
by state ownership and key elements of the command system continue to function, the capacity
of the nascent private sector to capture the state will be minimal. Indeed, the very dynamics of
state capture might be expected to differ in countries where some minimal threshold of private
sector development has not been crossed. As a result, though the BEEPS survey was
implemented in some countries where such a threshold has yet to be reached-namely, Belarus
and Uzbekistan-the results are discussed separately in order to recognize the unique nature of
the problem in these cases (see Box 1.4).15


11
Box 1.4: Corruption When Transition is Stalled
A number of former Soviet republics (including Belarus, Uzbekistan, and Turkmenistan) have made very
limited progress towards either a market economy or a multiparty political system. These countries retain
substantial similarities with key elements of the previous command administrative system.
In these countries the private sector has a small share in GDP and employment (20 percent in Belarus, 25
percent in Turkmenistan, and 45 percent in Uzbekistan, where in agriculture it may by grossly over-estimated)
and is subject to strict bureaucratic controls, state orders and lack of credit. There are still large scale price
controls with widespread subsidies and occasional shortages. Industrial policy is product- and enterprise-
oriented; central commands still abound. Multiple exchange rates, with overvalued official rates and
undervalued parallel rates, are distortionary and lead to low trade flows and high current account deficits. FDI
levels have remained extremely low. The EBRD's transition indicators rank Belarus, Turkmenistan, and
Uzbekistan lowest among all the transition economies.*
According to international perceptions, the level of corruption in these countries is quite high. Belarus is ranked
58th of 99 countries surveyed in the Corruption Perceptions Index by Transparency International, while
Uzbekistan is ranked 94th (Turkmenistan is not assessed). Yet according to the BEEPS survey, the percentage of
firms impacted by state capture in these countries is reported to be among the lowest in the region, as reported
below. Though there is much greater variation in the extent of administrative corruption, one of the slowest
reformers - Belarus - also records one of the lowest levels of this form of corruption. Does this suggest that
highly authoritarian regimes are more effective at preventing administrative corruption and state capture than
democratic systems?
Administrative Corruption                     State Capture
(bribes as a share of revenues)   (percent of firms affected by state capture)
Belarus               1.3                                   8.0
Uzbekistan               4.4                                   5.8
Source: BEEPS. See Figures 1.2 and 1.3 to put these numbers in perspective.
The answer lies in the nature of the BEEPS survey. The BEEPS data measure corruption by firms, primarily in
the private sector. Thus, state capture, as measured in this report, assumes the development of some degree of
autonomy between the state and the private sector. Where the private sector is barely developed and the state
continues to own and control most of the economy through administrative methods, this autonomy does not
exist. In such an environment, the BEEPS questions on state capture may not provide an adequate depiction of
the relationship between the state and firms.
When an authoritarian regime continues to exercise considerable control over both the executive and the
judiciary, administrative corruption may be kept in check. Although such scenarios could lead to relatively low
levels of capture and administrative corruption as empirically measured by the survey, this implies that the
transition is still in its infancy. Hence the lower incidence of corruption in Belarus is likely to reflect lack of
reform in the guise of a small private sector and lack of perceived market incentives - which also explains
lower incidence of state capture - and the maintenance of a stronger state administration. Uzbekistan's
combination of more advanced marketization with widespread controls is a more favorable environment for
administrative corruption, as well as some forms of state capture. But in both cases, the continued existence of
authoritarian controls may tend to constrain the measurable components of state capture and administrative
corruption. As a result, the empirical results would not be comparable with countries that are more advanced in
transition.
*These same three countries received the lowest scores in the region for political process, civil society,
independent media, and democracy, from Freedom House. Karatnycky, Motyl, and Graybow (1998, p16).


12
Finally, in contrast to administrative corruption, the degree to which a state is captured is
not necessarily related to the number of firms that engage in such forms of influence or the
amount they spend in doing so. Given that state capture is a function of the concentration of
economic power, only a small share of firms can be expected to have the capacity to capture the
state. In an extreme case, a single powerful monopoly could generate a much higher level of state
capture than a larger number of less powerful firms competing for influence. A measure of state
capture, therefore, should be based on the extent to which the state's decisionmaking is distorted
by the illicit influence of powerful firms and not necessarily on the number of firms actively
exerting such influence.
Despite these caveats, the BEEPS data provide the first opportunity to measure key
components of state capture across countries. The survey identified a number of specific
activities that fall within the definition of state capture, including: the "sale" of parliamentary
votes and presidential decrees to private interests; the sale of civil and criminal court decisions to
private interests; corrupt mishandling of central bank funds; and illegal contributions by private
actors to political parties.16 Firms were asked to assess the direct impact on their business, either
positive or negative, from each of these activities, regardless of whether they engaged in such
activities themselves. Thus, capture is measured not by how many firms engage in it, but by the
share of firms whose business is directly affected by it.
Table 1.1 presents measures of the share of firms in each country that report a significant
impact on their business from each one of the indicators of state capture. Clearly, state capture is
a significant problem throughout the region across a range of state institutions. Yet the variation
across the transition economies is striking. Across the different types of state capture, the sale of
parliamentary votes and mishandling of central bank funds are seen as having the most
significant and direct impact on firms. Box 1.5 provides a discussion of corruption in the
judiciary.
By taking the average of different components of state capture in each country listed in
Table 1.1, a general index of state capture can be developed. Though the index aggregates
several different forms of state capture affecting different state institutions, it is a useful measure
of the perceived extent of the problem across the institutions of the state. It should be recognized,
nevertheless, that in developing strategies to combat state capture, it may be necessary to further
unbundle the concept itself to identify which institutions within the state are most affected and
how the nature of capture differs across these institutions. Figure 1.3 compares this index across
the transition countries.


13
Table 1.1 Share of Firms Affected by Different Forms of State Capture
Country     Parliamentary Presidential  Central    Criminal   Commercial    Political  State
Legislation   Decrees     Bank        Courts      Courts       Party    Capture
Finance    Index
Albania           12           7           8          22          20          25         16
Armenia           10           7          14           5           6            1         7
Azerbaijan        41          48          39          44          40          35         41
Bulgaria          28          26          28          28          19          42         28
Croatia           18          24          30          29          29          30         27
Czech Rep.        18          11          12           9           9           6         11
Estonia           14           7           8           8           8           17        10
Georgia           29          24          32          18          20          21         24
Hungary           12           7           8           5           5           4          7
Kazakhstan        13          10          19          14          14           6         12
Kyrgyz Rep.       18          16          59          26          30          27         29
Latvia            40          49           8          21          26          35         30
Lithuania         15           7           9          11          14           13        11
Moldova           43          30          40          33          34          42         37
Poland            13          10           6          12          18           10        12
Romania           22          20          26          14          17          27         21
Russia            35          32          47          24          27          24         32
Slovak Rep.       20          12          37          29          25          20         24
Slovenia           8           5           4           6           6           11         7
Ukraine           44          37          37          21          26          29         32
Overall           24          21          25          18          20          20         21
Source: Hellman, Jones and Kaufmann (2000a). See the Annex 1 for details.
Figure 1.3. State Capture Index (share of firms affected by state capture)
50
40
30
l0
0
D
calclate fo eac conr wihi the sml.Suc:HlanJe,nd                 Kafmn (2000cca)
0O
a<                             a)        c~       n                a             0
a      a)  CO           LU   0                                 0
<                      N        M            -J'                   0
The thin line at the top of each bar represents the statistical margin of error (based on a single standard deviation)
calculated for each country within the sample. Source: Hellman, Jones, and Kaufmann (2000a).


14
Box 1.5: Corruption in the Judiciary
Corruption in any institution impedes its operation and distorts its objectives. However, corruption in the
judiciary is particularly damaging for several reasons. The legal system is one of the fundamental pillars of
a market economy whose role as arbiter of the law encompasses both the formulation and implementation
of public policy. In addition to deciding criminal cases, the courts are responsible for upholding property
rights, enforcing contracts, and settling disputes. As a result, corruption in the judiciary can display aspects
of both state capture and administrative corruption as the terms are used in this report.
Failure of any of these roles is costly, reducing incentives to invest or forcing firms to resort to more costly
private means of contract enforcement and protection. In addition to these direct economic costs, a corrupt
legal system has a wider impact, undermining the credibility of the state and making the implementation of
public policy more difficult. In particular, since the legal system will be the ultimate arbiter of any
anticorruption program, a corrupt judiciary will fundamentally undermine anticorruption efforts
themselves.
The index shows a rather wide gap between those countries with a high level of state
capture and those with a lower level. Beyond a certain threshold level, it would appear that state
capture generates a self-reinforcing dynamic pushing toward ever higher levels. According to the
index, the following states could be characterized as "high-capture"-Azerbaijan, Bulgaria,
Croatia, Georgia, Kyrgyz Republic, Latvia, Moldova, Romania, Russia, Slovak Republic, and
Ukraine.
Unlike the measure of administrative corruption, the index of state capture presented
above is not based on the behavior of firms, but on the perceptions of firms that such activity
affects their business. The BEEPS survey also includes a more direct measure of state capture
identifying which firms make unofficial payments to public officials to influence the formation
of laws, regulations, or decrees. Only a small share of firms report actively engaging in state
capture, ranging from a low of just under 5 percent of firms in Hungary to nearly 15 percent in
Latvia. Across all the transition countries, there is a reasonably high correlation (R=0.69)
between the number of firms that are actively engaged in capturing the state and the share of
firms whose business is affected by state capture. 17
Developing a Typology of Corruption in Transition
With measures of state capture and administrative corruption, we can identify variation in
the pattern of corruption across countries. A typology can be developed on the basis of the
interaction of both measures of corruption. For each index, countries can be plotted along an axis
ranging from "high" to "medium" in order to suggest the extent of the problem of each type of
corruption relative to the other transition countries. There is a clear threshold dividing countries
into high capture and medium capture groups. On administrative corruption, there is a more
continuous distribution of levels across the countries.


15
Figure 1.4 plots the transition countries according to the indices of administrative
corruption and state capture.' The scatterplot reveals a considerable degree of dispersion across
both indices generating a two-by-two matrix that groups countries by similarities in both the
level and pattern of these different dimensions of corruption. Though some countries clearly lie
within a particular sphere of the matrix, others have a more ambiguous position, potentially
straddling different spheres.
Figure 1.4. Typology of Corruption
Medium                                   High
45
A
40                                                             Azerbaijan
a Moldova                High
Latvia               a Russia          m Ukraine
30                m Bulgaria E                                   Kyrgyz
Croatia          aKry
X                                                Republic
25                      Slovak           Romania     m Georgia
_RepublicRoai
.  20
S15                                              Albania
n                Poland a   Czech     *  * Kazakhstan                       Medium
10             Estonia 0 Republic   Lithuania
Slovenia *                                   A
5                   Hungary
0
0           1          2           3          4           5           6
Administrative corruption index
The typology is not intended to define absolute and unambiguous divisions among
countries. Rather, it is presented as a heuristic device to highlight analytically and empirically the
differences in patterns of corruption across countries. Like all aggregate indices, the measures of
administrative corruption and state capture mask important variation across institutions within
the state and across actors engaged in these activities. As a result, the typology cannot replace the
critical role that individual country studies should play in identifying the extent and nature of the
corruption problem and in further unbundling of the forms of corruption identified in the report.
Indeed, the typology should be seen more as a guide for self-assessment by countries as to the
nature of the corruption problems they face than a definitive categorization of countries on these
complex dimensions of corruption.
The typology suggests a classification of four different patterns of corruption:
* In the high-high category, a serious problem of administrative corruption-and hence, weak
state capacity-is nested in a state highly subject to capture.


16
*   In the high-medium     category are countries that have been able to contain the level of
administrative corruption relative to other transition countries, but nevertheless have done so
in a context of high state capture.
*   The medium-high       category includes countries where the problem         of administrative
corruption remains the central problem, while the state has been less subject to capture by the
private sector than have other transition countries.
*   Countries in the medium-medium        category have lower levels of both state capture and
administrative corruption than other transition countries, though serious challenges remain.
The typology is a static snapshot taken at the time of the BEEPS survey (mid-1999) of
countries engaged in a dynamic process of evolution in both the development of state capture
and administrative corruption. How countries evolve into different patterns of corruption and
how they might progress (or regress) into different spheres of the typology will be examined in
subsequent chapters of this report. Recognizing these different patterns and analyzing alternative
evolutionary paths across these patterns could provide a stronger foundation for devising more
appropriate and finely tuned anticorruption strategies in different contexts.
1 For the most widely known exposition of this approach, see Klitgaard (1988).
2 For an early and interesting effort to unbundle analytically the concept of corruption, see Scott (1972). The
approach to defining and measuring different dimensions of corruption across countries derives from the following
background papers: Hellman, Jones, Kaufmann, and Schankermann (2000); Hellman, Jones, and Kaufmann (2000a).
3 As a result, the distinction between state capture and administrative corruption does not map directly into the more
familiar distinction between "grand corruption" and "petty corruption," which generally refers to the level of state
officials engaged in the corrupt transactions. Administrative corruption is most likely to cut across different levels of
government, as special discretionary exemptions in the implementation of laws and public procurement decisions
are a feature of both the higher and lower levels of government. State capture, by definition, only encompasses
levels of government empowered to make legislation, laws, rules, and decrees, though in some systems this could
also extend to different levels of government.
4 For an excellent review of the extensive literature on regulatory capture, see Laffont and Tirole (1993). For a
broader discussion of the roots of the concept of state capture, see EBRD Transition Report 1999, and Hellman,
Jones, and Kaufmann (2000a).
5 Indeed, the literature on regulatory capture tends to focus much less on corruption than on the inherent information
asymmetries in the nature of the relationship between the regulator and the regulated.
6 The area of public finance corruption is an especially important dimension that could warrant a separate
categorization of corruption. Politicians and public officials can alter the mobilization and allocation of public
resources and assets for their own private gain. Though this misappropriation of public resources could be classified
as a form of administrative corruption, it could be seen to have its own dynamics, especially when such corruption is
concentrated at the highest levels of the political system. This would cover instances of kleptocratic political
regimes, whose dynamics could be analyzed separately, though many of the normative implications of combating
state capture and administrative corruption would still be still relevant to this problem.


17
For a comprehensive description of the methodology and contents of the survey, as well as a descriptive analysis of
the key findings, see Hellman, Jones, Kaufmann, and Schankerman (2000a).
The most frequently used index of corruption is Transparency International's Corruption Perceptions Index, which
is a survey of surveys based on outside assessments of corruption and on a particular methodology subject to
changes over time (as well as its country coverage, which even though it has grown over the years, currently covers
only about one-half of all countries for which there is data). Any such aggregate comparative index will have serious
limitations in diagnosing in-depth governance and corruption challenges within a country. For that purpose, a new
set of diagnostic survey tools (for public officials, enterprises, and citizens) has been developed under a separate
project to help countries in addressing governance challenges, see Kaufmann, Pradhan, and Ryterman (1998).
9 For an analysis of existing governance and corruption indicators, see Kaufmann, Kraay, and Zoido-Lobaton (1999a
and b).
10 See Annex I for a description of the summary indicator.
1 It is possible that the manifestations of corrupt transactions across countries vary systematically with the level of
economic or political development, shifting from explicit bribe payments to more subtle types of benefits such as
equity stakes or commitments to future employment. If so, then measurements of corruption that rely exclusively on
explicit payments might understate the level of corruption in more developed countries.
1 See Annex 1.
13 The rankings of countries on this index of administrative corruption do not change significantly when statistically
controlling for the size and sector of firms.
14 For more detailed information on these household surveys, see Box 5.8: Diagnosing the Problem.
15 Other transition countries that might be considered in a similar category, including Tajikistan and Turkmenistan,
were not included in the BEEPS survey sample.
1 The decision to include the sale of court decisions to private interests and the mishandling of central bank funds as
elements of state capture requires some explanation. Courts are generally seen as institutions that implement existing
laws as opposed to making them, though the precedent-setting function of courts can blur these boundaries. In the
transition countries, where legal systems are still in the nascent stages of development, courts can be seen as playing
a more formative role in the development of the legal framework. As regards the central bank, the institution's role
in setting monetary policy and creating the regulatory framework for the developing financial system also blurs the
distinction between the formation and implementation of rules. While recognizing the difficulty of drawing concrete
boundaries within any particular institution, we have chosen to incorporate these institutions within the category of
state capture as a result of the unique nature of the transition period. Yet it is important to note that removing these
components from the index of state capture does not change substantially the ranking of countries on state capture
presented in Figure 1.3. Moreover, this does not have any effect on the positions of countries in the typology
presented in Figure 1.4, which guides much of the empirical work in subsequent chapters. See Annex 1.
1 By identifying "captor" firms, we can investigate the direct benefits and costs to such firms from engaging in
capture. A summary of these results is presented in Chapter Two.
8 Only countries included in the BEEPS survey are plotted in the typology, which thus excludes: Bosnia and
Herzegovina, FYR Macedonia, Tajikistan and Turkmenistan. Though Belarus and Uzbekistan were included in the
BEEPS survey, their results are discussed separately in Box 1.4 in recognition of the very different dynamics of state
capture in countries that have made minimal progress in transition.


Chapter 2: The Economic and Social Consequences of Corruption in
Transition Countries
In recent years, many studies have presented powerful empirical evidence on the
economic and social costs of corruption.' They have shown how corruption hinders investment
(both domestic and foreign), reduces growth, restricts trade, distorts the size and composition of
government expenditure, weakens the financial
system, and strengthens the underground
economy.     Most     importantly,   a   strong                    Typology Charts
connection has been demonstrated between           For the purposes of analysis in the following chapters,
corruption and increasing levels of poverty and  the countries have been divided into four groups on the
income   inequality. The    experience  of the     basis of thresholds of administrative corruption and state
transition  countries strongly  supports these     capture as in Figure 1.4. This produces a two-by-two
findings.   Yet   unbundling    corruption    in   matrix that groups countries on the basis of similarities
transition reveals the extent to which these       in both the level and pattern of corruption. However, it is
important to recognize that the composition of the groups
costs vary as a result of different patterns of    is based on the determination of the dividing lines, which
corruption.                                        is done here for analytical purposes only. As several
countries lay close to the thresholds, their inclusion into
The    costs  of   state  capture   and    either group is subject to a greater margin of error. For a
administrative    corruption    are    mutually    graphical depiction of the matrix along with the margins
reinforcing and are themselves influenced by a     of error, see Annex 1.
range of other factors. The fiscal distortions
caused by corruption, for example, erode the
quality   of    government     services,   with    Charts such as the one below will be used throughout
particularly serious consequences for the poor.   this report. These charts show the averages of the
The    negative   effects  of   corruption   on    relevant variable for the countries in each group of the
two-by-two matrix. The charts illustrate associations
investment and growth similarly exacerbate         between the relevant variable, administrative corruption
poverty   and   erode  the  tax   base, further    and  state  capture, rather than  causation. These
undermining the quality of public services.        associations do not take into account the potential
Though    this   chapter   will  examine    the    explanatory significance of other variables that might
consequences of corruption      in  a range of     influence the associations.
independent areas- growth and investment,
poverty and inequality, fiscal stability, public
service     provision,     and      government
credibility-the mutually reinforcing nature of
these costs and the complex lines of causation
should always be kept in mind.
Investment and Growth
1 4   i   w e l   t h a   i s                  . . ~ .a      d m in is t r t iv e
It is well established that investment isstate capture                           compton
significantly  affected   by    the   level  of
uncertainty in the business environment. By
increasing uncertainty, corruption raises the
effective cost of investment for the firm   and


19
countries having high levels of both administrative corruption and state capture, gross domestic
investment averages more than 20 percent less than in countries in the medium/medium category
of our typology.3
The negative effects of corruption are particularly clear from the firm-level performance
data. The average annual sales growth over the past three years was 17 percent for firms
reporting moderate levels of administrative corruption, declining to 10 percent for firms
reporting higher levels. The differential for investment growth is equally stark: 17 percent versus
9 percent, respectively. The differences hold regardless of firm size, origins, and line of business.
It is difficult to establish the direction of causality in this relationship. Weak firms might be more
inclined to rely on administrative corruption as a survival mechanism. Alternatively,
administrative corruption could directly weaken firm performance, raising questions as to
whether such bribery yields any selective benefits for the firm.
The effects of state capture on firm performance show a marked contrast. Where state
capture is reported to be prevalent, firms that pay bribes to influence the content of laws, decrees,
and regulations show significant increases in sales growth.4 In such environments, firms
engaging in capture grew by over 30 percent in the past three years, compared to a growth rate of
only 8 percent among other firms. Yet in countries where state capture is limited, engaging in
capture does not appear to bring any specific gains to the firm in terms of sales growth. Though
capture would appear to create an uneven playing field in certain contexts concentrating gains to
powerful firms, high levels of state capture are nevertheless associated with lower firm growth
rates overall-sales growth in low-capture countries averages 21 percent, compared to only 11
percent in high capture countries. The gains to capture for particular firms appear to be
associated with negative consequences for less influential firms.5 Again, the issue of the
direction of causality could be raised-capture could directly improve firm performance or
stronger firms could be more likely to engage in capture.
Though a small group of firms appears to
receive gains from  capture in certain contexts, the   Figure 2.1. Corruption and Output Decline
social costs of capture are substantial. State capture
represents a transfer of wealth among politicians,
firms, and the state via distortions in the underlying
competitive and institutional framework. Figure 2.1
shows that countries with high levels of state capture  cnei-           _
output from
and administrative corruption had the largest output    1989 to
7    9                1998
decline in the period 1989-98.7 Though the direction of
causation is ambiguous, a strong case can be made that
corruption contributed to the output decline, given its                         t    ntt
effects on investment and growth, the weakening of        state capture  medium medium  coruption
tax revenues, the misappropriation of credits and
subsidies, and the erosion of public sector services.


20
Poverty8
For so many individuals and families, the most immediate and visible consequence of the
transition has been a decline in their living standards. Even among the more advanced reformers,
poverty levels have expanded over the past decade at an alarming rate, as demonstrated in the
Prague 2000 report Making the Transition Work for Everyone. The expansion of poverty was
initiated by the collapse of GDP, which fell by 50 percent in the CIS countries and 15 percent in
CEE. Yet even with recovery, poverty rates have remained high as incomes of the poor have
failed to recover and inadequate social safety nets have left the most vulnerable groups
unprotected.
Figure 2.2 demonstrates that poverty is         Figure 2.2. Corruption and Poverty
highly correlated with administrative corruption.9
25
Surely, poverty can contribute to corruption as
poor countries have fewer resources to implement        20
and  maintain the monitoring   and  oversight    Percent of
necessary to contain the problem.'0 Yet corruption  o    10
also exacerbates poverty. As demonstrated above,  2r
corruption is empirically associated with lower
economic growth rates, weakening the main factor                         lgh acirinistrative
that can pull people out of poverty. Moreover,      state capture            corruption
corruption has a direct impact on the living
conditions of the poor."1
Corruption and service delivery: When corruption misdirects the assignment of
unemployment or disability benefits, delays eligibility for pensions, weakens the provision of
basic public services, it is usually the poor who suffer most. Such corruption undermines the
social safety net and may deter the poor from seeking basic entitlements and other public
services.
Bribery at the household level: The extent to which households engage in bribery is
strongly correlated with both administrative corruption and state capture as demonstrated by a
UNICRI cross-country survey of more than 25,000 households in 20 transition countries. For
example, in a country like Georgia, with high levels of both state capture and administrative
corruption, nearly 30 percent of households said they paid a bribe in the previous year, in marked
contrast to Slovenia where only 1.5 percent of households reported bribe payments. Though
corruption at the household level affects people at all income levels, the poor again appear to be
most seriously affected. Detailed household surveys show that the poor are the least likely to
know how to get proper treatment when an official abuses his position. In Latvia, for example,
only 31 percent of households in the poorest third of the population knew how to seek recourse
to deal with corrupt service provision, compared to 42 percent among the richest third of the
population. 13
Effect on small and micro enterprises: Within the economy, corruption is a highly
regressive tax as the BEEPS data demonstrate. Small enterprises across the region pay, on
average, more than twice as much of their annual revenue in bribes as do large firms. Such firms
are particularly hard hit by administrative corruption. Microentrepreneurs appear to be prime


21
targets for corruption. Household surveys in several transition countries demonstrate that bribery
at the household level is most strongly associated with participation in a microenterprise. In
Georgia, for example, poor households that earn unofficial income were four times more likely
to pay bribes than households without unofficial income. Corruption clearly hinders the ability of
the poor to help themselves out of poverty.
Inequality
As examined in the Prague 2000 report Making the Transition Work for Everyone,
inequality within the transition countries has increased at an alarming pace. In some countries of
the region inequality has now reached levels on par with the most unequal Latin American
countries. Though numerous factors contribute to the growth in inequality, corruption should
also be seen as a contributing factor. As the data on firm performance demonstrated, state
capture concentrates substantial gains to a narrow group of firms in a position to encode their
advantages in the basic legislative, legal, and regulatory frameworks that govern the economy.
By capturing the state, the "early winners" of transition gained fabulous wealth taking advantage
of arbitrage opportunities associated with partial reforms and laying claim to state assets at
highly undervalued prices. Privatization, in
particular, became a key focus for state capture    Figure 2.3. Corruption and Income
in some transition countries as some firms and              Inequality
political structures used illegitimate forms of
influence to concentrate productive assets in their
hands.14 In contrast, the poor gained little, if at
all, from the redistribution of what were once  ceffii
"social" assets. While the interaction between
corruption and income inequality is certainly
complex, the ultimate result has been clear:
income  inequality  has expanded  most in                      -w rrrtiv
countries with high levels of corruption and
capture, as demonstrated in Figure 2.3.I
Fiscal Implications
While increasing private revenues to public officials, corruption tends to have a negative
impact on public revenues. This impact operates through a number of channels. First, as the
surveys demonstrate, a substantial share of administrative corruption is directed towards tax and
customs officials, presumably resulting in lower tax
and customs payments by firms.   In the BEEPS           Figure 2.4. The Unofficial Economy
survey, one in nine firms said they frequently make       5
unofficial payments to tax inspectors or customs
officials, while half of the firms did so at least  Estiffated 30
occasionally. e Such  corruption  represents  a  ar       tn   t
impact~~~~~~~ one pbireeusThsipcoprtshough ical ube ofcanl ..rs,Ash
substantial indirect private transfer in many countries  sconow in
from the budget to public officials.
18                                          administrative
Second, as is clear in Figure 2.4, corruption is freq. uentlye cmkpeion
closely associated with the unofficial economy, the
SecondourcasBEEPSlear inrcFniguaen2.4,                andorruption100s


22
size of which can have profound fiscal implications in many transition countries.19 When firms
produce for the unofficial economy, they underreport economic activity or avoid the state
entirely. This creates competitive advantages that can drive honest competitors from the market,
20
thereby generating further corruption and fiscal shrinkage.2 The reduction of tax revenues
reduces the funds available for public services, providing firms with fewer incentives to operate
officially. Once underground, such firms pay bribes to avoid detection and punishment. The
fiscal implications in some countries have been staggering. In Ukraine, the government recently
offered an amnesty for an estimated US$20 billion in "gray capital" kept offshore.21
Third, corruption in procurement, assignment of subsidies, and outright theft leads to an
exaggerated flow of funds out of the public coffers. Corruption in procurement, for example,
leads to waste of public resources for often inferior quality products and services, and ultimately
may deter honest vendors from doing business with the state. In a survey in Georgia, the need to
make unofficial payments was the most cited reason that firms said they do not participate in
state tenders.22
The   fiscal  weaknesses   exacerbated  by    Figure 2.5. Quality of Macroeconomic
Governance
administrative corruption and state capture contribute
to weak macroeconomic performance. As Figure 2.5
shows, transition countries with the lowest levels of
administrative corruption and state capture have the
most   effective  institutions  for  macroeconomic
governance.23 Though   macroeconomic instability
certainly creates a fertile ground for corruption, the
fiscal implications described above suggest that
corruption  contributes  to  the  macroeconomic          -dium         mlim administrative
instability  as well.                                state capture  hit
Credibility of the State                         Data Source. BEEPS
As later chapters of the report will demonstrate, combating corruption requires strong and
credible political leadership. Yet this is precisely the aspect of the political system that is most
24
seriously undermined by administrative corruption and state capture. The BEEPS data confirm
that approval ratings for the key institutions of government drop sharply with increasing levels of
state capture and administrative corruption: only 38 percent of firms in countries in the high-high
category of the typology expressed satisfaction with the political leadership, compared to 56
percent in the other transition countries. Firms in the high-high category also expressed the least
confidence in the capacity of the legal system to uphold their property and contract rights: 58
percent of firms in these countries complained of insecure property and contract rights, compared
to 35 percent of firms in the medium-medium category. Corruption erodes trust in the institutions
of state, which in turn weakens the state's capacity to fight corruption. A 1999 household survey
in the Slovak Republic confirms the point: respondents who believed that corruption was
widespread were more than twice as likely to doubt the credibility of the government's
anticorruption campaign than those who perceived corruption to be more limited.25


23
A   dangerous byproduct of this                 Figure 2.6. Organized Crime as a Problem
erosion  of trust is increasing     crime.                       Doing Business
Problems with both organized crime and
600/
street crime are highly correlated with
state    capture    and     administrative      Prcenth
corruption. As Figure 2.6 suggests, more         sous to
than twice as many firms in countries in       prblew
the high-high category identify organized
crime as an obstacle to their business
than in the medium-medium        group of                                       high
Figre2.6OganzeCrmeasa Pirsroble
countries.                                           state capture  medium  medium  corruption
distrust feed on each other, deepening and entrenching the problems. If and when political
leaders committed to fighting corruption arrive on the scene, in many countries they face a
cynical population that has strong doubts about the credibility of the state. Where states have
been captured, reformers must overcome a deep chasm of distrust before an anticorruption
program can take hold. Yet by failing to address the problem of corruption, they are confronted
by a vicious circle of lower investment and growth, higher poverty and inequality, greater fiscal
imbalances, and weaker delivery of basic public services.
Studies include: Mauro (1995, 1997, 1998), Wei (1999a, 1999b, 2000), Campos, Lien, and Pradhan (1999),
Kaufmann (1997), Tanzi (1998), Tanzi and Davoodi (1997), Kaufmann and Wei (1999), Wei and Sievers (1999),
Johnson, Kaufmann, and Zoido-Lobaton (1998a), Johnson, Kaufmann, and Shleifer (1997), Gupta, Davoodi, and
Alonso-Terme (1998), Anderson and Marcouiller (1999).
2 Corruption is also a notorious deterrent of foreign direct investment. However, since foreign investment is often
motivated by abundance of natural resources, which is in turn associated with high levels of corruption, the
statistical relationship between foreign direct investment, capture, and corruption in transition countries is
ambiguous.
aGross domestic investment in 1997 was 27 percent of GDP in countries with medium levels of administrative
corruption and state capture, compared to 21 percent in countries with high levels. The difference is significant at
the 5 percent level in a pair-wise t-test.
In the BEEPS survey firms were asked how often they take unofficial payments to influence the content of laws,
decrees, or regulations. Responses to this question were used to identify "captor" firms, whose individual
performance can then be measured. Only a small share of firms (generally less than 5 per cent of the sample in each
country) reported engaging in capture. There is, however, a correlation between the number of firms that report
engaging in state capture and the number of firms that report experiencing a significant impact on their business
from state capture. See Heilman, Jones, and Kaufmann (2000a).
' This remains true even after accounting for other factors, such as firm size, sector, ownership, and origin, that
influence firm performance.


24
6 Though it would be difficult to assert the direction of causality with certainty, there are indications that the gains to
firms come as a result of capture. First, bribing to influence rules and laws is more likely to be a voluntary
transaction between the firm and state officials and, hence, unlikely to be a form of direct extortion by state officials.
Thus, presumably, firms would not engage in it unless it brought clear advantages. Second, the gains to capture are
strongly influenced by the nature of the broader environment in which capture takes place. Capture is associated
with specific gains to captor firms only where some threshold of capture has been reached in the country. This
strengthens the view that capture actually generates such gains.
7 See Annex 1.
8 This section draws on Anderson and others (1999). See also Gupta, Davoodi, and Alonso-Term (1998), Dethier
(1999a, 1999b).
9See Annex 1.
1o Treisman (2000) found evidence that economic development may lead to lower corruption.
1 Recent empirical studies on corruption's disproportionate impact on the poor include Knack and Anderson (1999)
and Gupta, Davoodi, and Alonso-Terme (1998). See also Narayan and others (2000) for the impact of corruption on
the poor in the words of the poor themselves.
12 The International Crime Victim Survey was carried out in transition countries in 1996 and 1997. Country-level
statistics are reported in Zvekic (1998).
' Anderson, Dethier, Dudwick, Kuehnast, and Shkaratan (1999).
14 EBRD (1999) finds that for a given level of privatization the quality of governance in countries with relatively
low levels of capture is substantially higher than in countries with higher levels of state capture.
15 See Annex 1.
16 However, administrative corruption payments in the areas of tax and customs administration are often paid to
reduce the discretionary power of bureaucrats to levy taxes and customs rather than to reduce standardized tax and
customs levels.
17 In virtually every country where detailed surveys have been undertaken, the customs service is identified as an
organization in which bribes are frequently paid. Examples include Albania (Kaufmann, Pasha, Preci, Ryterman,
and Zoido-Lobaton (1998)), Georgia (Anderson, Azfar, Kaufmann, Lee, Mukherjee, and Ryterman (1999),
Tajikistan (Mirzoev (1999)), Ukraine (survey by "Intellectual Business Foundation," cited in Holovaty (2000)).
Even in more developed transition countries, customs is noted by enterprises as one of the organizations at which
bribery is common: Latvia (Anderson (1998)), and the Slovak Republic (Anderson (2000)).
1 See Annex 1.
19 Johnson, Kaufmann, and Shleifer (1997), Johnson, Kaufmann, and Zoido-Lobaton (1998a, 1998b), Schneider and
Enste (1998).
20 This vicious circle has been explored by Johnson, Kaufmann, and Shleifer (1997) and by Johnson, Kaufmann, and
Zoido-Lobaton (1998a and b). "The unofficial economy accounts for a larger share of GDP when there is higher
bureaucratic inefficiency and discretion, and also when firms experience a higher tax and regulatory burden and
more bribery and corruption."
2 Financial Times, April 3, 2000.
22 Anderson, Azfar, Kaufmann, Lee, Mukherjee, and Ryterman (1999).
23 Macroeconomic governance is an index measuring the extent to which policy instability, exchange rate instability,
and inflation are an obstacle to business. See EBRD (1999) "Transition Report 1999: Chapter 6 - Governance in
Transition" and Annex 1 for details.
24 The findings described here are consistent with recent empirical work showing that levels of trust are higher in
countries with lower levels of bribery. Zak and Knack (1998).
25 Anderson (2000).


Chapter 3: The Origins of Corruption in Transition Countries
The transition from socialism is a unique historical process. Never before have countries
attempted such a radical and simultaneous transformation of both their political and economic
institutions. Underpinning these transformations has been a complex set of reforms that entail
building the basic institutions of state, creating the foundations of a market economy and
transferring wealth from the state to the private sector on a large scale.
Why has the transition been marked by state capture and administrative corruption?
Certainly, corruption has deep roots and existed in these countries long before transition. Due to
fundamental differences in the nature of corruption in market and nonmarket economies, it is
difficult to compare the levels of corruption before transition with the current period. Hence, it is
impossible to provide definitive evidence of the effect of transition on corruption. But it is clear
that the simultaneity of political and economic reform that characterizes the process of transition
has introduced scope in some nations for powerful interests to influence the structure of state
institutions and the formulation and implementation of economic policy to their own advantage.'
Corruption in this setting has been facilitated by three factors: (i) the rewriting of an
unprecedented volume of laws, regulations, and policies; (ii) the extraordinary redistribution of
wealth from the state to the private sector; and (iii) the virtual absence of institutions either
within or external to the public sector that could effectively check the abuse of public office
during the transition in many countries.
At the same time, this report demonstrates the considerable variation in levels of state
capture and administrative corruption across the region. What factors explain this variation? Part
of the answer is rooted in the different institutional and structural legacies with which countries
entered the transition. Institutions for public administration were more developed at the onset of
transition in certain countries, especially those with a longer experience of sovereignty.
Countries with legal and institutional traditions that emphasized the rule of law appear to have
begun the transition with an advantage. Previous exposure to market-oriented institutions in
those countries that had adopted variants of market socialism may have shaped the receptiveness
to reform. Economies with a high level of natural resources are more likely to generate powerful
interests seeking to capture states and lay claim to the concentrated gains stemming from such
resources.
Institutional legacies and other initial conditions have a strong influence on the "first
moves" of the transition process, such as choices about the structure of political institutions and
the pace and comprehensiveness of economic reform. These choices set in motion unique
transition paths that favor particular economic and social groups and shape incentives for further
reforms. Countries where the transition path led to a concentration of economic power in a
setting of weak basic institutions became especially vulnerable to state capture and
administrative corruption.
While initial conditions explain an important part of the variation in the pattern of
corruption in the region, initial conditions tell only part of the story - much of the variation
remains unexplained. This feature suggests that other factors, such as the rise of effective leaders
who are able to implement and sustain policies that are inimical to corruption, are also critical to
the development of the transition path. Through an understanding of the role of initial conditions


26
and especially institutional legacies is crucial for developing effective strategies to combat
corruption, this does not imply that some countries were predestined to generate high levels of
corruption in the transition. Political will and policy choice have a key role to play in
determining the susceptibility of a country to corruption.
Institutional Legacies
Research on the origins of corruption worldwide2 confirms that corruption is rooted in
poorly functioning institutions, as well as in policies that undermine free trade and competition.
The nature of the institutional legacies at the start of the transition differed substantially across
the region despite the apparent monolithic nature of communism. The main features of this
variation are explained below.
Accountability and Repression. The old system entailed the fusion of the state and the
economy. Authoritarianism obliterated the separation of the legislative, executive, and judicial
functions of state. Most civil liberties were suppressed. Social organizations, such as trade
unions, professional clubs, and youth organizations, did exist, but were pervaded by the
Communist Party. Civil society as a sphere of interaction autonomous from the state was highly
attenuated. When independent social movements did emerge, for example Solidarity in Poland
and Charter 77 and later Civic Forum in Czechoslovakia, they were perceived by the Communist
Party as threats to its system of control.
The Communist Party attempted to control the behavior of public officials using a
mixture of incentives and repression. One key incentive derived from the system of appointing
individuals to key positions in government and the economy. These appointees, known as the
nomenklatura, had special privileges and, as a consequence of their positions, unique access to
goods and services in short supply. The Communist Party carefully monitored its officials, using
a system of mutual oversight and repression. The internal security services enlisted citizen
informants, who provided detailed and often incriminating information on their family, friends,
and colleagues.
The very process of central planning also served to limit, to some extent, the discretion of
bureaucrats. Economic activity was regulated by plan targets. Centralized control was
maintained over financial flows through a monobanking system, in which finance closely
followed the plan. Cash emissions and cash transfers were strictly controlled. Foreign trade for
the entire economy was monopolized in a highly centralized bureaucratic structure. Though the
actual practice of central planning did leave a great deal of discretion to bureaucrats at all levels,
the system did place certain boundaries on corruption.
At the onset of transition, most of these controlling structures were formally dismantled,
although in many countries they have come to play new roles. New institutions of
accountability-to be derived from such models as the separation of state functions, participation
by the population in oversight of the state, and better systems of public administration-have
been slow to emerge in many countries. Into the vacuum, preexisting nomenklatura networks
and new economic elites have secured positions of dominance in the transition environment
creating a new fusion of economic and political power. In many countries, this has created fertile
ground for state capture and administrative corruption.


27
The Culture of State Intervention. One of the key legacies of communism was a "culture
of policymaking" in which the state played the dominant role in intermediating economic
relations. Bureaucrats were assimilated into an environment in which the state determined
suppliers and customers, set prices and wages, provided finance, controlled distribution, and
oversaw most aspects of enterprise behavior. Though many of these instruments of intervention
have been abolished or curtailed, a number of them still persist. Old habits remain widespread-
especially in countries where bureaucratic turnover in the early years of transition was low- as
bureaucrats tend to respond instinctively to reports of economic dysfunction or crisis by directly
intervening in enterprise affairs.3
This ingrained tendency toward         Figure 3.1. Statehood and Corruption
state intervention, which varies across
the region, creates the potential for
corruption, especially when regulated
entities have little recourse to appeal
unfair  treatment.  Given  that   the
transition is a period when a significant        60
body of new regulations must be
formulated, it also exacerbates the risk  statehootury5
that corrupt bureaucrats will enshrine
possibilities to extract bribes in the new       4o
legal regulatory codes.
3C                             Administrative
Variation  Across   Countries.                                       h     C
Institutional legacies have differed far
more   across the   region  than  the
communist faqade had ever revealed. Data Sown.: BEEPS
Empirical analysis suggests that these
differences have had a profound impact on the susceptibility of countries to state capture and
administrative corruption through a number of channels. 4 First and foremost, these legacies
influenced the level of development of a country's system of public administration. Figure 3.1
shows that countries with a longer
experience of sovereignty have faced             Figure 3.2. Habsburg Legacy and
less dramatic levels of both    state                       Corruption
capture and administrative corruption. 5
These countries appear to have begun               100%....
the transition with more developed
public-sector institutions and better-              75%
Share of countries
trained officials.                      in caegr that
were formerly part 5%
As   shown   in  Figure  3.26       onry
countries that were formerly part of the            25%
Habsburg Monarchy appear to have                                           medium
0%                    -g     Administrative
benefited from  the former empire's                  0%                  hI   Amnsrtv
medium             hg    Corruption
legacy of a strong civil service and                              high
judicial administration, as well as closer               State Capture
contacts with the West.7 They were also     Data Source: BEEPS


28
more likely to have adopted variants of socialism during the communist period (i.e., market
socialism and labor management), which provided for a smaller role of the state in the economy
and greater development of market institutions. One important consequence of these mutually
reinforcing legacies of stronger public administration and a reduced role of the state is less
administrative corruption.
Many of the countries with a longer history of sovereignty also have more developed
civil societies and a stronger tradition of collective action as part of their political process. The
tendency under communism for social movements to try periodically to assert a liberal political
and economic agenda was particularly
strong in Central Europe and in other       Figure 3.3. Democracy and Corruption
countries  where   civil  society  had
historically played the largest role. These
countries were among the first to realize the
delicate relationship between economic
growth and democracy, and initiated
Measure of      N l
reforms beginning in the 1960s aimed at    Derocracy
political and economic liberalization. While
many   of  these  reforms  were  later
suppressed, these experiences provided a                                     Administrative
blueprint for the way in which social                mhditm
movements could have a profound impact              S
on the process of change. In fact, countries
with the strongest traditions of democracy  Data Source BEEPS and Adelman and Vujovic, 1997.
were led into transition by opposition
movements and have emerged, not coincidentally, as the states least vulnerable to capture by a
concentrated set of private interests, 8as shown in Figure 3.3.9
Economic Legacies
Incentives rooted in the structure of the economy also appear to have played a crucial role
in explaining the variation in the level and pattern of corruption across the region. In some
countries where national wealth is concentrated in a few highly productive assets, potential
'windfall gains' have tempted powerful individuals or economic groups to engage in state
capture. Efforts by private interests to lay
claim to these assets and then to build  Figure 3.4. Resource Endowments and Corruption
anticompetitive  barriers to protect their
assets have been in evidence in Azerbaijan,
Russia, Kazakhstan, and Turkmenistan, all
30%
richly endowed with natural resources, as     Share 33
Economicrie Leace
well as in many countries along the transit  category that are aydl
routes for the distribution and sale of these  resource rich rg
resources. Figure 3.4 suggests that across           10%  p
the region state capture has been more
prevalent in countries well endowed with              0%
natural resources.10                                       high
State Capture
Data Source, BEEPS


29
In most transition countries, dramatic declines in output and dislocations associated with
the transition sharply reduced public revenues. As inflation soared in the early stages of
transition, real wages in the public sector fell substantially. In many countries, salaries for
bureaucrats at the start of transition had fallen below subsistence levels. Moreover, weak
payments discipline and budgetary shortfalls meant that public sector workers were often not
paid for months at a time. In such an environment, bureaucrats become vulnerable to corruption
as they search for ways to supplement meager wages.
Transition Paths
Variations in these institutional and economic legacies across countries in the region, often
referred to as "initial conditions," have already been shown to have had an important effect on
the outcomes of transition.12 These initial conditions influenced the early choices about the basic
structure of the political institutions governing the transition as well as the speed and
comprehensiveness of the first moves on economic reform. As a result, countries began to follow
divergent transition paths from the very beginning, with equally divergent outcomes in terms of
economic performance and the extent and pattern of corruption.
In many of the Central and Eastern European countries, the transition was launched and
fundamentally shaped in the early stages by broad-based coalitions within civil society. The
initial political institutions were forged, in many of these cases, through roundtable negotiations
representing a wide range of social groups and political movements. In the CIS, in contrast, the
transition was largely initiated from the top down and, in some countries, even came as a fait
accompli following the disintegration of the Soviet Union. In much of the CIS, the existing
Communist Party leadership managed the early stages of transition and civic participation
remained weak. The difference between these alternative exit routes from the communist system,
which is illustrated in Box 3.1 by a comparison of Poland and Russia, has had powerful
implications for the establishment of political accountability within these countries.


30
Box 3.1. Comparison of the Transition in Poland and Russia
The way in which institutions and incentives can work together to create or obstruct opportunities for corruption is
well illustrated by a comparison of two neighboring countries: Poland and Russia. Poland has a long history of
sovereignty,13 having adopted orthodox socialism only after the Second World War. Shortly following Khrushchev's
denunciation of Stalin in 1956, a worker's strike in Poznan led to the introduction of market socialism and limited
civil liberties. Periodic strikes over the next two decades created episodic pressure to reform, and eventually led in
1980 to the emergence of Solidarity, a trade union which, together with the Catholic Church, became the basis for an
effective opposition movement to the Communist Party. In Poland, 10 million people- one in two adults-were
members of Solidarity at the start of the transition. In 1989, 29 delegates from the Party, 26 from Solidarity, and 3
Church observers met in three working groups, or roundtables, which culminated in the emergence of a
parliamentary political system with proportional representation and an approach toward economic reform that was
built upon a social consensus and thus an encompassing set of social interests.14 These choices, in combination with
Poland's comparatively stronger skills in public administration, appear to have placed certain limits on the extent to
which state capture and administrative corruption could emerge.
Russia and many other countries in the former Soviet Union entered the transition in a completely different way.
Unlike in Poland and other Central European countries, political and economic liberalization-glasnost and
perestroika, respectively-were not initiated by civil society, but by the Communist Party leadership. Following the
break-up of the Soviet Union and the emergence of new states, choices about the structure of the political system
and the initial economic reform program were not made through a process of broad social consultation and
consensus, but by an elite group of reformers in a style reflective of Russia's autocratic past. Like many other
countries in the CIS, Russia adopted a presidential system with highly concentrated executive powers and weak
institutional restraints within the state. Without the benefit of institutional safeguards, the process of economic
reform became especially vulnerable to capture by a narrow set of private interests eager to garner control over
lucrative state assets, especially the highly prized natural resource companies.
Figure 3.5 shows that countries in which there was a clear break with the past leadership
at the start of transition have a significantly
lower incidence of state capture, as well as              Figure 3.5. Change in Leadership and
administrative corruption.'5 Early change in                         Corruption
leadership is one indicator of the extent to
which existing networks of power and
Share Of 75%
influence inherited from   the old system  were     on on
broken up and faced with competition from          c.agnge in 50%
alternative  elites.16 Such  change    not only    fiee'i in
irs electioni2
brought in new    talent often oriented toward
reform, but also created new mechanisms of                    0%  edimnCrruptio
political accountability, in many cases rooted                   Sa Capture
in   political   competition    and    enhanced   Data Source: BEEPS
participation by civil society.
One of the most controversial measures taken by some countries to ensure a break with the
past is a policy known as lustration.17 This policy, which was adopted in the Czech Republic,
Poland, and Estonia, among other countries, prohibits former officials of the internal security
apparatus and their informants from accepting public-sector employment. In sharp contrast,
officials of the Communist regime and remnants of the internal security apparatus continue to
retain important political and economic positions in such countries as Kazakhstan, Uzbekistan,
Turkmenistan, Tajikistan, Belarus, Armenia, and Azerbaijan. Although the power structure in


31
Russia became more diffuse in the 1990s, old patronage networks and clan structures are
particularly strong in various regions and republics within Russia.'8
The nature and extent of the break with the old regime set in motion the main driving
forces of alternative transition paths, namely the pace and comprehensiveness of political and
economic reforms and personal freedoms. These factors can be considered the key transmission
mechanisms creating the conditions for different levels of state capture. Figure 3.6 demonstrates
the relationship between economic
reforms and civil liberties and the        Figure 3.6. Economic Reform, Civil Liberties,
extent of state capture across the                     and State Capture
region.19 In fitted regressions, the                       (ted values)
level of state capture is lowest in the
systems with lowest and highest
levels of civil liberties.                      0.3
In  the  most authoritarian      State  0.2
systems in the region, the capacity    Capture
of independent private firms-to the             01
extent that an independent private                                      Lo Econoric Reform
rfigh Econorric Reform Countries
sector exists at all-to capture the               High Civil Medium
Liberties  Civil  LowbCiils
state is minimal. In such countries,              Countries Liberties Libnries
firms generally remain subordinated                     Countries
to  the  state,  both  in  terms  of      Data Source: BEEPS; Freedom Hoise; Hellm, Jones, aid Kaufffam,
ownership and control, and have
little capacity to influence government decisionmaking. However, though state capture by
private firms is low in such systems, other forms of capture-such as capture of the state by
political leaders to benefit their own private interests-may be more prevalent, given the lack of
accountability on such leaders. Unfortunately, the state capture index used in this report does not
measure such forms of the problem.
The environment for state capture by private firms does appear to be generated by a
certain minimal threshold of political and economic reforms. Partial political reforms that break
with the previous communist system but do not provide new mechanisms of accountability such
as political competition, internal checks and balances, or civil society oversight generate the
greatest opportunities for a narrow set of private sector interests to capture the state. In these
countries, the extent of civil liberties (and other checks on abuse of power) is insufficient to
counterbalance the loss of control that resulted from the dismantling of the communist system.
Yet the figure suggests that once a threshold of political reforms has been crossed, the extent of
state capture inherent in the transition process can be constrained to significantly lower levels.
Figure 3.6 also illustrates the potential interaction between political and economic
liberalization in reducing capture. The countries of the region have been grouped into three levels
of economic reform-high, medium      and low-based on their average scores on EBRD's
transition indicators, an annual measure of progress in transition across nine areas of
liberalization and structural reform. For any given level of progress on civil liberties, the figure
suggests that progress in economic transition is associated with lower levels of capture. Of
course, cause and effect are difficult to untangle in these complex and highly interdependent


32
processes. There is much evidence to suggest that the pace and comprehensiveness of economic
reforms reduces economic rents associated with distortions in a partially reformed economy.
Reducing the concentration of economic rents weakens the incentives for private sector actors to
invest the considerable costs, in terms of money, time, and influence, necessary to engage in
state capture. At the same time, the processes of deregulation and limitation of the powers of the
state to intervene in the economy reduce the range of laws, regulations, and policies that are
potentially "for sale."
The progress of both political and economic reforms is in itself partly an outcome of the
level of state capture in a given country. Those with the power and resources to capture the state
can have a vested interest in preventing reforms that threaten their influence or eliminate the
economic distortions on which their concentrated private gains are based.20 As a result, partial
political and economic reforms appear to generate state capture which, in turn, weakens the
power and capacity of the state to pursue such reforms further. This accounts for the difficulty of
emerging from state capture once it takes hold. But it also suggests that when political will has
been marshaled through critical elections, through the entry of new collective actors into the
political and civil arena, and through exogenous pressures and opportunities, progress in political
and economic reforms has had a powerful impact in reducing state capture.
The Redistribution of Assets
In addition to the simultaneous processes of creating new political and economic
institutions, a key characteristic of the transition has been the massive redistribution of assets
from social ownership to private ownership. It is perhaps this redistribution, highly concentrated
in time, that has provided the strongest incentives for capturing the state in the transition
countries. By capturing the state in the process of privatization, private actors sought to
transform their de facto political influence into de jure ownership stakes that would secure their
advantages in the emerging market economy. Numerous examples exist in all countries in
transition where ownership or control of key state assets was transferred through nontransparent
means to those with political influence; corruption has played a key part in this process.
Perhaps the most prominent example of nontransparent privatization in the region has been
the loans-for-shares scheme, which was implemented in Russia in the fall of 1995. According to
this scheme, the Russian government obtained short-term credit from major Russian banks using
its shares in Russian enterprises as collateral. When the government defaulted, the banks were
able to keep the shares. The implicit prices on these shares were well below their market value.21
Nontransparent privatization has not only been a problem in Russia and the CIS
countries. In October 1994, the head of the Czech privatization agency was caught taking a bribe
equal to about US$300,000 in connection to the sale of a dairy.22 In Hungary, eight of the ten
members of the privatization agency were forced to resign in October 1994, following
allegations of corruption in the sale of formerly state-owned enterprises.
Unfortunately, there is little systematic research on the conditions that make particular
methods of privatization more or less vulnerable to corruption.23 Early in the transition, many
observers believed that mass privatization offered governments a simple and transparent
mechanism for transferring the bulk of state assets to the general population. Despite the


33
simplicity of the method, enterprise managers were often able to manipulate the market value of
their firms or exploit weaknesses in institutional arrangements for shareholder protection in order
to be able to retain control. These methods included illegally threatening workers who sold
shares to outsiders and issuing new shares in order to dilute the power of outsiders.24
Privatization through a case-by-case method, while complex and time-consuming, has
allowed some countries to structure the sale of the assets to avoid some of the problems
associated with state capture, though this method has also been open to abuse. Large
privatizations are vulnerable to corruption whatever the method employed, as the experience of
advanced countries frequently demonstrates. Recognizing this temptation, some governments,
such as Romania, have delegated responsibility for organizing privatization to internationally
recognized investment firms.
The Role of Foreign Investment and Assistance
It is often suggested that inflows of foreign direct investment (FDI) can help reduce
corruption by importing higher standards of corporate behavior with potentially powerful
demonstration effects in local markets.25 Others argue, in contrast, that FDI can increase the level
of corruption as foreign actors use bribery and other forms of influence to penetrate new markets
where they lack existing contacts and networks.
Fiure 3.7 depicts the relationship between FDI and corruption using data from the BEEPS
survey.2 Firms are divided into three groups: (i) domestic firms with no FDI; (ii) firms with FDI
headquartered in the domestic market; and (iii) firms with FDI headquartered overseas. The
charts depict the propensity of each of these firm types across the region to pay bribes for
administrative corruption and to engage in state capture through bribery to influence laws,
decrees, and regulations. FDI firms headquartered in the local market face similar levels of
administrative corruption as domestically owned firms and are just as likely to engage in state
capture.27 However, FDI firms headquartered abroad do report substantially lower levels of both
state capture and administrative corruption.


34
Figure 3.7. Foreign Direct Investment and Corruption
3.5%1                                                     14.0
12 0'.
10 0
Bribes as a    -       --- -      -  -            -     Share of firms  80
share of                                               that capture the
I                                state
revenues                                                   t a0t
4 01
domestic firms, with  FDI, with domestic  FDI, with overseas  .3.'., m . In., a   c.bi.:  FE  war. :.e' 
no FDI       HQ           HO                             with no FD1   HQ          HQ
foreign direct investment                                foreign direct investment
Data Source: BEEPS; Hellman, Jones, Kaufmann (2000b)
A closer inspection of these relationships within different groups of countries reveals that
FDI appears to have a very different impact in different environments. Figure 3.8 shows that in
countries with high levels of administrative corruption and state capture, FDI firms with
domestic headquarters are substantially more likely than domestic firms to engage (or be
compelled to engage) in both forms of corruption. In other countries, all forms of FDI are
associated with less corruption. The negative impact of FDI in domestic firms is particularly
striking in a number of high capture countries-such as Azerbaijan, Georgia, Latvia, Moldova,
and Ukraine-where these firms are more than twice as likely to engage in state capture than are
non-FDI firms. While foreigners might be inclined to invest in sectors and firms that are prime
targets for corruption, this result raises doubts that foreign direct investment imports higher
standards of corporate behavior with the ability to influence practices in high corruption settings.
Many of the high-corruption countries are in the CIS, where the institutional arrangements for
28
corporate governance are especially weak.     Thus, to the extent that foreign investors in
companies with domestic headquarters seek to curb corrupt practices, they may not have
sufficient instruments in the CIS for influencing the behavior of managers.


35
Figure 3.8. Foreign Direct Investment in High-corruption Countries
Share of firms that                                      Share ol bribes in
capture the state                                                 .
high state capture      Z7                                h igh adrnimstrallw ceforupon
Domestic                     medurn administrative corupbon
Domestic                   medium state capture                FDI Domestic HO a O    g
FDl Domestic HQ  FDI Overseas HQ                   loregn direct investment  FDI Overseas HQ  country gmoups
foreign direct investment  country groups
Data Source: BEEPS; Hellman, Jones, Kaufmann (2000b)
Foreign aid might be subject to similar dynamics. A recent comparison of countries
worldwide (unfortunately excluding countries in transition) indicates that foreign aid can induce
corruption, as competing social groups use corruption to extract benefits from this aid.29
Countries in transition are also vulnerable to this problem, especially where institutions for
public resource management are most seriously underdeveloped.
Vicious or Virtuous Circle?
The process described in this chapter suggests that institutional and economic legacies had
a profound impact on initial choices of political institutions and on the pace and substance of
economic reform. In countries with weak institutions and strong incentives for corruption,
restraints on the abuse of public office were insufficient to check the emergence of state capture
and administrative corruption. In countries with more favorable legacies, these problems are still
present, but are less severe.
Figure 3.9. Variation Within and Between Sub-regions
State Capture                                 Administrative Corruption
6
I  ______ Azernaijn_______1lpAzerbailan
Moldova     pAzerbailan__Azerbai_Kyrgyz
~g     fUkraine                                             I       deu        kArmeenia
Croatia  L   Bulgaria  R                                  L      A  a   U
asll >omanovak                w oriaRoanaKazakhstan
20                     RomaJa                                                    -Russia
ag,,Slovak                                ,Rtulgaria
10        Czech  Lithuania               -Kazakhstan  2       Po En
Hunga  Estonia           IArmenia                          Latvia
a        Slovenia
0   Central and  Baltic South-eastern Central Caucasus  Central  Central and  Baltic South-eastern Central  Caucasus  Central
Eastern Europe states  Europe  CIS    Asia           Eastern Europe states  Europe  cis  Asia
Source: BEEPS


36
The institutional and economic legacies inherited from the past are important for
understanding current levels of state capture and administrative corruption, but this does not
imply that these levels are pre-determined by such legacies. The standard geographical
categorizations of transition countries actually mask wide variation in corruption levels as
demonstrated in Figure 3.9. While the initial conditions discussed in this chapter explain some of
this variation, a large share cannot be attributed to past legacies, suggesting that other factors,
such as the rise of effective leaders and strategic policy choices, have a major impact on the
nature and extent of corruption.
Yet countries can get trapped into a vicious circle, in which partial political and economic
reforms become self-reinforcing. Limited reforms enable private interests both in and outside the
state to shape policymaking to their personal advantage, which in turn reduces the likelihood of
further structural reforms. Economies trapped in this vicious circle suffer devastating economic
consequences.
The tenacity of this trap depends on the underlying incentives for reform in a country.
Countries in which civil society is repressed, political competition is constrained, and
institutional restraints within the state are limited generally face weak internal pressures for
reform. Countries which are less reliant on foreign aid or are not candidates to join international
bodies such as the EU or WTO face fewer external pressures for reform. Such countries could
face a "partial reform trap" unless the political will to break the stranglehold of vested interests
on the reform process is marshaled.
Can countries also become locked in a virtuous circle? We cannot emphasize too strongly
that no country in transition is sufficiently developed to be immune to problems of corruption; in
fact, no country in the world is immune. Even the most advanced transition countries remain at
risk of backtracking as increasingly influential private sector interests seek to shape the
remaining agenda of structural reform to their own advantage. Yet the proper institutional
reforms and policy choices are mutually reinforcing and can have a demonstrable impact in
reducing corruption levels, as a number of countries have already shown (see Chapter 6).


37
See for example Holmes (1999) for a discussion of the effects of multiple simultaneous transitions.
2 For example, see Mauro (1995); La Porta and others (1997, 1999); Easterly and Levine (1997); Ades and Di Tella
(1999); Treisman (2000); Broadman and Recanatini (2000).
3 Murrell, Dunn, and Korsun (1996) developed this concept to describe the process of economic liberalization in
Mongolia.
4 Underpinning this analysis is a series of firm-level regressions, in which state capture and administrative
corruption are explained by firm, industry, and country characteristics. These characteristics include: (i) the size,
ownership form, and age of the firm; (ii) dummy variables describing the industry of the firm and its membership in
a business association; and (iii) variables measuring institutional legacies of a country, such as the natural log of the
number of years it was a state in the last century, a dummy variable indicating whether it was a member of the CIS,
a dummy variable indicating whether it had been part of the Habsburg Monarchy, a dummy variable indicating
whether it was centrally planned (as opposed to labor managed or market socialist), an index of political
liberalization at the onset of transition, an index of economic liberalization at the onset of transition, a dummy
variable indicating whether it was resource-rich, and more. Generally, those variables described by the figures in the
text were those that were significant and robust to many different specifications. Surprisingly, a dummy variable
measuring whether a country is in the CIS was useful in explaining administrative corruption, but not state capture.
5 The measure of experience with sovereignty is the number of years during the previous century that the country
was a sovereign state. See Annex 1.
6 See Annex 1.
7 In contrast, countries that were formerly part of the Russian, Prussian, or Ottoman Empires do not share this
legacy. Some countries, such as Poland, were formerly part of multiple empires.
As explained later, deeper exploration of the relationship between democracy and corruption indicates that, while
significant political reform impedes corruption, partial political reform may facilitate corruption.
9 See Annex 1.
1o See Annex 1.
" In fact, below-subsistence wages may attract a disproportionate share of dishonest workers as honest workers
forgo job opportunities in the public sector.
12 Studies of the determinants of economic policy decisions, such as the depth and speed of liberalization, clearly
indicate that institutional legacies at the onset of transition have had a profound impact on policymaking. See, for
example, de Melo and others (1997) and Heybey and Murrell (1999) for an analysis of the role of initial conditions
on reform policy and growth.
13 And in fact was an important European power between the twelfth and nineteenth centuries.
14 While the particular modality of social opposition to communism was different in Hungary and Czechoslovakia,
similar stories can be told about the importance of their institutional legacies in the shaping of their political
structures and economic policies.
- See Annex 1.
16 One important network consists of former members of the internal police, especially the KGB. See TraCCC
(2000) for a summary of the role of former KGB in fostering corruption.
17 See Rosenburg (1995) for a provocative investigation into the human rights dimension of lustration in the Czech
Republic, Germany, and Poland.
" TraCCC (2000). Also see Wedel (2000) for a discussion of the role of informal networks in transition.
19 This section draws on Hellman, Jones, and Kaufmann (2000a), which includes a full econometric treatment of the
relationship between political and economic liberalization and state capture.
20 Hellman (1998).


38
21 Lieberman and Veimetra (1996).
22 Holmes (1999).
23 One study that examines this link is Kaufmann and Seigelbaum (1996).
24 Desai and Goldberg (2000).
25 One potential explanation for these higher standards is linked to the pressures on foreign firms from the OECD
convention legal covenants-now ratified by most countries-that make transnational bribery illegal. In the case of
the U.S. foreign investors, such laws predate the OECD convention by more than 20 years.
26 Regressions of corruption on enterprise characteristics such as size, ownership, age, industry, and FDI confirm the
associations between corruption and FDI depicted in Figures 3.5 and 3.6. See Heilman, Jones and Kaufmann
(2000b) for a full characterization of the relationship between FDI and different forms of corruption.
2 In this graph, the measure of state capture is the percentage of firms actively engaging in state capture. See Annex
1.
2 Djankov and Murrell (2000).
29 See Svensson (1998).


Chapter 4: A Multi-pronged Strategy for Combating Corruption
To be effective, efforts to reduce corruption must move beyond a narrow response to its
immediate manifestations to a broader approach of addressing its underlying causes. The
preceding chapters have demonstrated the complex mix of historical legacies, institutional
factors, and policy choices that have influenced the incidence of state capture and administrative
corruption across the region. Dealing with these problems will require a multi-pronged strategy
tailored to the specific pattern of corruption in each specific country.
To date, anticorruption programs have largely focused on measures to address
administrative corruption by reforming public administration and public finance management.
But with the increasing recognition that the roots of corruption extend far beyond weaknesses in
the capacity of government, the repertoire has been gradually expanding to target broader
structural relationships, including the internal organization of the political system, the
relationship between the state and firms, and the relationship between the state and civil society.
Figure 4.1. Multi-pronged Strategy: Addressing State Capture and Administrative Corruption
Institutional Restraints:        Political Accountability:
* Independent and effective judiciary  *Political competition, credible poitical parties
*Legislative oversight          *Transparency in party financing
*ndependent prosecution, enforcement  *Disclosure of parliamentary votes
*Asset declaration, conflict of interest rules
Competitive Private Sector:
Civl P rt i cratic   civil servicewi  Economic policy reform
Civilud           e  o  ie r ti atio n :  C om petitive  restructuring  of  m o no po lies
*Frl eedom g of f raftn ws*Regulatory simplification for entry
*Pubic harigs o drft lws-Transparency in corporate govemnance
*Role for media/NGOs .
*Collective business associations
Public Sector Management:
*Meritocratic civil service with monetized, adequate pay
*Budget management (coverage, treasury, procurement, audit)
*Tax and customs administration
*Sectoral service delivery (heath, education, energy)
*Decentralization with accountability
Experience has demonstrated that there is no single model to determine how these
relationships should be structured to minimize the risks of corruption. Indeed, a wide range of
diverse models is available from contemporary practice and historical experience. Though the
methods may differ across countries, the goals are the same: enhancing state capacity and public
sector management, strengthening political accountability, enabling civil society, and increasing
economic competition.


40
This chapter defines and describes five key building blocks of an anticorruption strategy,
illustrated in Figure 4.1. The next chapter shows how the strategy can be tailored to countries
confronting different profiles of corruption.
Increasing the Accountability of Political Leaders
The first block consists of actions that can be taken to increase political accountability.
Political accountability refers to the constraints placed on the behavior of public officials by
organizations and constituencies with the power to apply sanctions on them. As political
accountability increases, the costs to public officials of taking decisions that benefit their private
interests at the expense of the broader public interest also increase.
Accountability rests largely on the effectiveness of the sanctions and the capacity of
accountability institutions to monitor the actions, decisions, and private interests of public
officials.  Transparency    via   public
scrutiny has proven to be one of the most   Box 4.1: Disclosures of Conflict of interest
powerful forms of monitoring public
officials. Such   transparency   can  be    Lawmakers and policymakers in countries liable to state
fostered by a number of measures, capture are uniquely vulnerable to conflicts of interest.
Laws designed to prevent decisionmaking in a situation
including:  opening    sessions  of  the    of conflict of interest typically require state officials to
parliament, government, and the courts to   declare their assets and may also regulate the receipt of
the public; registering lobbying activities;  gifts by public servants. Such laws feature in many
and publishing the voting records of        countries, including Albania, Czech Republic, Estonia,
parliamentarians,   annual   reports  of    Georgia, Latvia, Lithuania, Poland, and Russia, but vary
govenmet bdie, tial ecods,andthe widely in the effectiveness of their implementation and in
government bodies, trial records, and th    the extent to which they require public access to the
decisions  of   judges.  Among     these,  information contained in declarations. Latvian law
effective laws on disclosure of conflict of  reinforces the incentives created by disclosure by
interest, including the receipt of gifts and  penalizing illicit enrichment of officials who cannot
other benefits   received  from   private  justify possession of assets in excess of their normal
sources,sources of income. Lithuania has successfully used the
asset declaration law to remove corrupt public officials
throughout the region (see Box 4.1). To     from office.
be fully effective, however, such laws1
need oversight and implementation bodies. Public access to information on the interests of high
public officials, as found in Georgia and Latvia, can reinforce the impact.
Effective sanctions on politicians can be enhanced most effectively through a meaningful
degree of political competition in the electoral process. Such competition increases the likelihood
that alternative candidates and parties will seek to expose corruption in government or hold
politicians accountable for the poor performance associated with high levels of corruption. The
issue of corruption has been a key factor in elections across the region in such countries as
Bulgaria, the Czech Republic, Latvia, and Poland, among others. However, excessive political
competition can become a destabilizing factor if it leads to fragmentation of the political system
or if it undermines the legitimacy of existing state institutions. This is most likely to occur when
political parties are organized largely around rival ethno-linguistic groups with competing claims
to the definition of the nation-state, as in Bosnia and Herzegovina. Excessive political
competition can undermine state capacity and thus create conditions especially conducive to
administrative corruption, but conducive to state capture as well.


41
Political competition is most effective in promoting accountability when it is channeled
through organizations that provide broad constituencies with vehicles-such as mass-based
political parties and interest groups-to express their collective demands to political leaders.
While mass-based political parties are gaining credibility in CEE, in many other transition
countries they remain unstable and tenuously linked to broad constituencies. This exacerbates
politicians' dependence on powerful firms and financial interests-sometimes outside the
country's borders-for sources of financing and on electoral tactics such as vote-rigging,
intimidation, and acquiring a monopoly over election coverage by the media. It is imperative that
political parties be held to the same standards of accountability as those described above.
Effective, well-monitored rules on political party financing are of particular importance (see Box
4.2).
Accountability mechanisms need not be entirely based on external constituencies and
competitive pressures. Indeed, in certain contexts, such mechanisms can also be created within
government bureaucracies by establishing ethics codes, regulations on lobbying, disciplinary
committees, prohibitions on conflict of interest, and mandatory disclosure of income and assets.
Ensuring credible sanctions and effective internal monitoring of bureaucratic behavior is critical
to the success of such an approach.
Strengthening Institutional Restraints
The institutional design of the state can be an important mechanism in checking
corruption, in particular, the effective development of institutional restraints within the state most
effectively achieved through some degree of separation of powers and establishment of cross-
cutting oversight responsibilities among state institutions. Effective constraints by state
institutions on each other can diminish opportunities for the abuse of power and penalize abuses
if they occur. An independent and impartial judiciary is often the most important constraint, as
the existence of genuine legal recourse underpins the credibility of other institutions of the state
and allows these institutions to be credibly challenged when needed.


42
Box 4.2: Political Party Financing: Experience And Mechanisms'
Experience worldwide shows the immense difficulties of installing an effective system of party funding that will not
be open to abuse. Many countries have experienced malpractice in public procurement that provided kickbacks for
party funding, as well as a plethora of other improper channels involving state-owned enterprises, privatization, and
the leverage afforded by appointments and control rights at all levels of government. However, international
experience also shows that regulation of party funding can be effective if well-designed, backed by effective
sanctions, and accompanied by a parallel diffusion of appropriate ethics and norms. Ultimately it is committed
politicians and citizens who have asserted the principles that should govern party financing and have driven through
new laws and regulations. These rules need oversight, enforcement, and monitoring. This requires reliable judges or
electoral authorities and an active investigative press. In some cases, the shame-and electoral consequences-of
political exposure have proved effective. There is no single prescription for success, as party financing rules have to
operate in an environment of institutions and degrees of rule-respect that varies across countries, but many countries
have found a selection of the following mechanisms to be helpful.
*   Leave a paper trail. Ensure that all donations and other sources of party revenue are made public, that donors
and the amounts of their donations are identified in the public record, and that candidates disclose links to
lobbyists, as well as sources, types, and amounts of support, both before and after elections. Expenditures and
their purposes should be similarly published and available for audit.
*   Ban the use of state resources for political purposes. Parties in government should not use state funds, postal
services, cars, computers, or other assets for political purposes or in election campaigns.
*   Limit expenditures. Make party politics as inexpensive as possible. Usually the demand exceeds the supply of
funds, leading to a search for funding that may breach legitimate frontiers. There is a lot to be said for reversing
this relationship by mechanisms used in a large number of Western European and other countries: (i) allocating
free time slots on TV and radio to qualifying political parties, with no additional time allocation permitted; and
(ii) imposing legal limits on spending, with actual expenditures subject to audit and to effective sanctions in the
case of breaches of the limits.
* Consider public funding. Many countries have established partial public funding, recognizing that political
parties play a public interest role: they make an essential contribution to political contestability and the
decentralized expression of diverse values and interests. Public funding reduces the scope for private interests to
"buy influence" and can also help reinforce limits on spending, because of the electorate's resistance to
excessive public expenditure.
*   Build public service neutrality. Ensure that the public service is politically neutral and that public servants are
neither allowed nor required to make contributions to political parties as a way of obtaining public sector
employment. This will contribute to a meritocratic public service that will resist party bias and will encourage
decisionmaking in the public interest.
*   Limit types of donors. Some countries have outlawed donations from both public and private sector companies,
such as France since 1995, or foreign donations.
*   Ensure oversight. Set up an authoritative and independent Electoral Commission or Court to be responsible for
the integrity of all issues regarding party finance and electoral rules. Such commissions have been set up in
Canada, India, Ireland, and South Africa.
The institutional arrangements governing the distribution of the legislature, executive,
and judiciary vary across Central Europe and the CIS. Most CIS countries have presidential or
semipresidential systems, while most countries in Central Europe have parliamentary systems,
within which the balance of power varies considerably. In principle, devolution of powers from
the central to subnational levels of the state could also contribute to institutional restraints. But
experience within the region indicates that decentralization in the absence of effective capacity
and accountability often increases vulnerability to corruption. In many countries of the region,
corruption at the subnational level has become a particularly serious problem.


43
Audit organizations can also have an important role. A good-but rare-example is
Poland's Supreme Audit Chamber, which investigates and publishes reports on abuses in
procurement, management of public assets, and other diversions of public funds. For full
effectiveness, State Audit Offices should be backed by parliamentary committees that review and
follow up on their reports. By contrast, watchdog enforcement agencies have a mixed record and
have too often been subject to capture themselves. A condition for their effectiveness is the prior
establishment of a core of strong, independent, and credible professionals in the judicial,
prosecutorial, and police arms of the state.
A frequent complaint is favoritism of the state in cases brought by citizens. Box 4.3
describes mechanisms to prevent and resolve disputes between citizens and the state.
Box 4.3: Transparency and Recourse in Administrative Decisionmaking
Government decisions are less prone to corruption when they are predictable, transparent, and accountable.
Administrative procedures law provides the legal foundation for sound government decisions by providing
rules for the way government bodies behave. These procedures protect the rights of citizens by
guaranteeing participation in government decisions by interested parties, openness and transparency of
decisions, adequate responses to public inquiries, and the availability of recourse. Mechanisms of recourse
include appeal within government bodies, judicial scrutiny, and ombudsmen. Explicit administrative
procedures allow citizens who are affected by administrative decisions to know that decisions will be made
2
according to predictable rules rather than the will of the administrator.
In the context of corruption, one of the crucial differences between CEE and CIS countries involves
differences in administrative procedures. Most countries in Eastern Europe possess at least basic guidelines
for administrative decisionmaking and dispute resolution, unlike most in the former Soviet Union. In an
attempt to strengthen public administration and protect the rights of their populations, a number of
transition countries are developing their own administrative procedures. Latvia, for example, is introducing
legislation to create a system of administrative courts dedicated to the adjudication of disputes between
citizens and the state. The Latvian government considers the introduction of such courts to be integral to
the efficiency and credibility of government decisionmaking.
Judicial systems in the region are generally considered to be capable of independent
decisionmaking, although in some countries judiciaries have not yet established effective
autonomy. In others, their capacity for independence is not always matched by performance, and
lower courts are often managed by the Ministry of Justice with oversight provided by the
procuracy.
Raising judicial credibility is a challenging task. Judicial independence is critical but must
not come at the expense of accountability. Reforms specifically aimed at raising judicial
accountability consist of setting and monitoring judicial performance standards and ethical
behavior, introducing greater transparency in relations between judges and litigants, publishing
trial records and judicial decisions, and introducing transparent methods of case assignment.
Private lawyers may also play an integral role in facilitating judicial corruption, by acting as an
intermediary between the judge and the litigant. The enforcement of professional behavior in the
legal professions can be strengthened by professional associations that set and monitor standards
for legal practice and by developing a system of consumer protection.


44
Budgets should be aligned with judicial functions. A mismatch between judicial functions
on the one hand and judicial capacity and resources on the other has placed severe limits on the
ability of the judiciary to deliver its services efficiently and honestly. Such a mismatch also
creates an imbalance between demand for and supply of judicial services. In the Slovak
Republic, for example, there have been serious backlogs of company registration applications
and in Poland long delays are common in the registration of land transactions through
underresourced courts. Few courts are specialized in commercial matters. Largely as a result of
the perceived unreliability of the formal institutions, there is a disturbing trend in some countries
for commercial disputes to be settled privately and occasionally by force.
Where budget stringency persists, judicial functions should be trimmed and alternative
modes of delivering these functions should be explored. For example, registry functions can be
assigned to special-purpose bodies; the enforcement of court decisions in the Slovak Republic,
although still regulated, has been partially devolved to the private sector.
Independent prosecution remains a crucial challenge for countries in the region. Often the
legal framework for anticorruption is incomplete or unclear. Because direct evidence of corrupt
acts is often difficult to obtain, many countries have criminalized activities that are often
associated with corruption, such as laundering proceeds from corruption and other crimes. Box
4.4 provides more detailed information on the legal framework for prosecution of money
laundering cases.
Box 4.4: Anti-money Laundering
"Dirty" money is "laundered" to make it appear "clean" when illegally obtained money is transformed so
that it appears to have come from legitimate sources. The series of transactions can be complex, but three
basic steps are typically involved: placing the illicit cash in the banking system, layering transactions to
make it difficult to trace the funds, and integrating the illicit money with money from legitimate sources.
Legislation is needed that defines money laundering, declares it a criminal offense, and designates a state
authority to receive suspicious transactions reports, maintain and analyze these data, cooperate with other
countries in investigations of financial crimes, and coordinate efforts with international institutions.
Financial institutions should be obliged to review transactions and report suspicious activities to
authorities, and to have written policies and procedures in place so that the institution can be confident its
customers are not using it for the purpose of money laundering.
Some countries in transition have anti-money laundering laws in place, but few enforce them effectively.
Common weaknesses include: failure to criminalize the transfer or possession of money obtained from
illegal activities; failure to oblige non-bank financial institutions (such as insurance companies, securities
firms, investment companies, or cambios) or businesses often used by money launderers (casinos,
bookmakers, garages) to report suspicious transactions; failure to provide the legal basis for seizure of
proceeds from illegal transactions; and lack of capacity and resources to enforce the law.
Strengthening Civil Society Participation3
As stakeholders in the quality of governance and institutions mediating between the state
and the public, the organizations that comprise "civil society"-Citizens groups,
nongovernmental organizations, trade unions, business associations, think tanks, religious


45
organizations-can have an important role to play in constraining corruption. Under
communism, however, civil society was severely repressed. In a few cases, the power of
collective will managed to overcome the repression- a strong trade union movement in Poland
helped create political competition and supported social cohesion through the painful periods of
reform, and civic associations were a feature of other CEE transitions. Yet such organizations
were the exception; early in the transition, and -ven today, NGOs in many countries are still in
the early stages of development or remain as appendages of the state.
More recently, there has been an emergence of greater civil society activism in the
transition countries regarding corruption. Twenty-six civil society initiatives against corruption
in 17 transition countries were surveyed for the purposes of this report. These grass-roots4
initiatives demonstrate the varied role that participation by civil society can play in fighting
corruption. Most of the activities have revolved around three key themes: creating public
awareness about corruption; formulating and promoting action plans to fight corruption; and
monitoring governments' actions and decisions in an effort to reduce corruption. (See Box 4.5
for an example.)
Box 4.5: Giving the People Voice
The People's Voice Programs in Ukraine aims to build integrity at the municipal level through strengthening the
voice of citizen groups demanding better governance and services, and by facilitating more responsive public
organizations. Through surveys, information on the problems associated with major services is gathered. This
information is then used by citizen groups to put pressure from below on local leaders to improve service delivery.
The project also supplies technical assistance to municipal agencies that should enable them to be more responsive.
Surveys of households, enterprises, and public officials have revealed a high level of dissatisfaction with the quality
of public services, while also showing that most citizens (more than 90 percent) have never filed any complaints,
believing that this would be fruitless. The survey information has been widely disseminated through the media,
public discussions, conferences, and through NGOs. Initial implementation results are encouraging. The municipal
officials in Ternopil reacted to the survey results by creating task groups to work on the most critical problems
revealed by the surveys. These groups are currently developing proposals to deal with the problems identified. An
interesting initiative has emerged in the city in response to the citizens' demands- Service Centers, a one-stop shop
where citizens can pay for all municipal services. The Service Centers are also proposed to be used for filing and
monitoring the citizens' complaints.
To raise public awareness, organizations have often made use of country surveys on
corruption, service delivery surveys, and diagnostic assessments. Seminars, conferences, and
workshops have helped to publicize information about the patterns and severity of corruption and
to develop action plans. These can include attempts to influence new legislation that will aid
corruption control or to lobby for new institutional devices to prevent or penalize corruption.
Others focus on judicial reform and freedom of information. Advocacy for legal and judicial
reform, business deregulation, privatization, and procurement reform are common themes of
civil society interventions. Some monitoring activities have focused on privatization plans,
procurement reforms, allocation of housing, and legal reforms.


46
Civil society is most effective when the government treats it as an ally, rather than an
enemy. In the Slovak Republic, for example, the national chapter of Transparency International
was entrusted with the first draft of the National Program for the Fight Against Corruption and
has regularly been invited to monitor procurements and other state decisions.
The Role of the Media6
Free and open media help check the level of corruption by uncovering and shedding light
on abuses. The greater openness felt by the media since the fall of communism has brought with
it a plethora of stories of fraud, corruption, and criminal activity, making the media perhaps the
most persistent institution in the fight against corruption. Journalists have paid dearly for this: in
the territory of the former Soviet Union alone, more than 200 journalists have been killed in the
line of work as they investigated stories on corrupt officials or criminal gangs.7 Though most
countries of the region now have a free and open press, many factors continue to weaken the
media's potentially powerful contribution to limiting corruption, including: lingering state
controls; conflicts of interest generated by ownership arrangements; and corruption in the media
itself. Legal guarantees to free speech form the foundation of a vibrant media. But the press may
yet be inhibited in other ways, most notably by libel laws and intimidation. In Turkmenistan, the
media are expressly forbidden by law from publishing any sort of criticism against another
person or institution except criticism issued by the president himself. In some countries, violence
against journalists has resulted in strong self-censorship.
Lingering state pressure even on privately owned media is still a serious problem. In
Croatia, for example, journalists who criticized the regime of former President Tudjman found
themselves faced with surprise tax inspections, shut out of the national distribution monopoly, or
cut off from the national airwaves.9 Similarly, journalists in Ukraine who dig up information
about public officials have reported various forms of state intimidation.10 Government
monopolies on printing, supply of paper distribution, and television signal transmissions
continue in many countries, creating pressures for self-censorship.
The conflict of interest that characterized the old system of state-owned media has in
many instances taken on a new form, as the business interests that are capturing the state also
gain control over the media. While the news business could be a major industry with high profit
prospects, the partisan nature of the ownership structure has limited its growth and development.
An appropriate system of corporate governance within the media would ensure that the editorial
side of the business operated separately from the business and revenue side. Allowing free entry,
particularly of fore,_. press if it is non-partisan and competitive, can also help mitigate the
problem of "media capture." Foreign investment in media in the Baltics has helped to create a
highly diverse and competitive media culture. In Russia, where media organizations are often
firmly aligned with concentrated business interests, a Russian language daily was recently
created by foreign investors whose leading marketing an le is the newspapers' independence
from the internecine battles among the so-called oligarchs.
Some countries, most notably those in Central Europe and the Baltic states, have made
giant strides toward creating a free press, while at the other extreme, many of the Central Asian
republics and Belarus still repress the media. Freedom of the media is highest in countries with
the lowest levels of administrative corruption and state capture. (See Figure 4.212.) A policy of


47
openness, formalized in laws guaranteeing free access to information, strengthens tools for
oversight and enlists the media as an ally in controlling corruption.
Creating a Competitive Private Sector
The transition period has witnessed a       Figure 4.2. Media Repression
rapid concentration of economic power,
while strong remnants of the state's capacity
to intervene in the economy, inherited from
the previous command system, have survived  D
in many countries. The privatization process  journaism are
has been susceptible to manipulation by
powerful state actors, enabling them to gain
control of substantial parts of the economy.
In many cases, monopolies were privatized in          r..rnr.itte
the absence of regulatory frameworks. The      stats capture              corruption
rapid concentration of economic power was
reinforced by corruptly assigned subsidies,  Source: BEEPS and Freedom House
guarantees,  directed  net  lending,  and
corporate tax arrears. Banks that were infiltrated by criminal networks are now the foundation of
money laundering and other scams. Market entry has been hindered by the oppressive
application of start-up rules and inspections; lack of access to bank and equity finance; and
licensing and permit delays that disproportionately penalize small businesses. Inadequate
mechanisms to register asset transactions foster unclear ownership structures, often masking
manipulation by powerful economic and state interests. This combination of concentrated
economic power and bureaucratic control has created a receptive environment for state capture
and administrative corruption. Tackling this concentration of power and reducing discretionary
and coercive intervention constitute the most formidable challenges of the transition, especially
in light of the political constraints (see Box 4.6).


48
Box 4.6: Challenges of Confronting State Capture in the Energy Sector
Large infrastructure monopolies represent powerful economic interests that are able to exercise considerable
influence over legislation and regulations even in cases where the scope of their activities has been formally reduced.
To cite three examples:
The introduction of foreign investors to the oil sector in Kazakhstan reduced the scope of Kazakhoil's activities.
Despite this, Kazakhoil remains extremely powerful and was able in 1999 to secure changes in the Petroleum Law
that strengthened its own position in the industry at the expense of making the investment climate in the sector less
attractive to foreign investors.
In the latter part of 1998, there was widespread speculation in Russia that international donors would push for the
break-up of Gazprom as a condition of their further lending to Russia following the August 1998 financial crisis.
Gazprom responded to this by securing passage through the Duma of the Gas Supply Law. This law guarantees
Gazprom's right to continue to operate as a monopoly.
The Russian Government made a commitment to enact a pipeline law. Both Gazprom and Transneft have a vested
interest in such a law and succeeded in pushing a draft law through a first reading of the Duma late in 1999. The draft
law contains provisions that are of significant concern to foreign investors and was strongly opposed by the Ministry
of Fuel and Energy. Despite this, the law passed its first reading. Gazprom subsequently realized that certain
provisions in the draft law were also detrimental to its interests and with the change in the composition of the Duma
following the 1999 Russian elections, the law was taken back to the drawing board.
The ability of powerful economic interests to capture the state can be constrained by: (i)
economic policy liberalization; (ii) introducing greater competition, especially in concentrated
sectors, by lowering barriers to entry, requiring competitive restructuring, and clarifying
ownership structures; (iii) regulatory reform at all levels; (iv) a stronger and more transparent
framework for corporate governance; (v) instruments of voice for business associations, trade
unions, and concerned parties; and (vi) transnational cooperation.
Economic Policy Reform.3 Although significant increases in economic liberalization
have occurred since the onset of transition, many countries still have not significantly
deregulated prices or other aspects of production or trade. For example, in Russia and Belarus,
prices are controlled for several important product categories and public procurement at
nonmarket prices remains substantial. Implicit price subsidies, in the form of tax and utility
arrears, are commonplace in countries such as Georgia, Moldova, and Azerbaijan. Such
interventions 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.


49
Enhancing Competition. Transparency in formulating and implementing economic
policy is crucial to combating corruption, especially in the areas of privatization and regulation.
Most of the state assets that remain to be privatized are large and many are in the natural
resource or infrastructure sectors. Competitive restructuring of these 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. Box 4.7 outlines the different approaches to business
regulation that have been utilized in three of the most successful of the transition countries.


50
Box 4.7: 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.14
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.'5 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 rules as much as it requires the elimination of unnecessary rules.
Corporate Governance.16 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. Box 4.8 provides an example
of ethics reform in firms in transition countries that was achieved through collective action
within the business community.


51
Box 4.8: Business Ethics
Business associations in some EU-accession countries, such as the Czech, Hungarian, and Polish Business Leaders
Forums, have focused on strengthening ethics codes. There have also been a number of business-led efforts in
Russia to improve standards of corporate behavior. A small management consulting company in St. Petersburg,
Sovereign Ventures, prepared a Declaration of Integrity in Business Conduct requiring signatory companies to adopt
a "no-bribe" pledge. More than 100 companies have so far signed the Declaration. In St. Petersburg, the Association
of Construction Companies has expelled nine companies for violating their rules of ethical conduct, which cover
"unfair" practices such as failing to fulfill building contracts.
Business Associations. A challenge
for countries in transition is to find ways in         Figure 4.3. Business Associations and
which diverse private interests can compete                       Corruption
with one another in an open and transparent
way. One mechanism, often overlooked in
transition countries, is the use of collective    Shar of fis In
business     associations    as     legitimate     members of 2-)
instruments to represent collective interests    asoitns t
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         State Capture  high  high  Corruption
problems    of  capture  and   administrative    Source: BEEPS
corruption.
Transnational Cooperation. Foreign direct investment does not always import higher
standards of corporate behavior into transition countries, especially those in which state capture
and administrative corruption have already reached high levels.18 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. As described in Box 4.9, 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.


52
Box 4.9: International Collective Action
Council of Europe Criminal Law Convention on Corruption (European Treaty Series No. 173;
http://conventions.coe.int). 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. 174;
http://conventions.coe.int). 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
(http://www.oecd.org/daf/nocorruption). 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.
Reforming Public Sector Management
A fifth building block consists of reforms in the internal management of public resources
and administration to reduce opportunities and incentives for corruption. Reforming public sector
management and public finance requires: instilling meritocracy and adequate pay in public
administration; clarifying governance structures; enhancing transparency and accountability in
fiscal management; and policy reforms in sectoral service delivery. In most cases, greater public
oversight can play a key role in the reform process.
In part due to the legacy of the nomenklatura, the practice of political patronage in public
administration continues to be an important source of corruption in transition economies.
Political patronage can be a source of accountability to the patron, but it can also undermine
continuity and the development of standards, institutional values, and memory in the public
sector. This opens the way to conflict of interest, misprocurement, and theft of public funds. The
short-term and uncertain nature of many political appointments also decreases the time horizons
of public sector workers, creating incentives for predatory behavior.


53
A first step in reforming public sector management is to eliminate patronage by
instituting meritocratic systems for appointment, promotion, and performance evaluation and,
where feasible, establishing an independent civil service oversight body. Poland, Latvia, and
Kazakhstan are now starting down this path. In parallel it will be important to increase salaries,
relate them to skill and responsibility, and regularize the extensive nonsalary benefits that
provide broad scope for discretion and corruption. This applies especially to CIS countries where
average monthly salaries are often less than US$30, although there are a host of ad hoc and
uneven noncash allowances. Poland and Georgia, for example, allowed higher salaries for public
servants who successfully cleared competitive examinations but fiscal and political constraints
have prevented other countries from undertaking such reforms.
Review of governance and functional structures in ministries and agencies should also be
a high priority. Especially in the CIS countries, administrative restructuring needs to focus on
separating regulatory and economic functions. Some administrations have moved central
government functions into quasi-private-sector structures. These structures blur the lines of
policy direction and accountability and also create an unnecessarily large number of highly paid
supervisory jobs which can serve to multiply political contacts and opportunities for pay-offs.
Off-budget agency funding contributes to budget fragmentation and lack of transparency. There
is also a small but important category of agencies, such as the committee on statistics, that should
not be subject to political direction and whose independent functioning needs to be safeguarded..
Such agencies need statutory protection, elimination of party political appointments, professional
management, and freedom from political interference.
To improve transparency and accountability in fiscal management it is crucial to ensure
full budget coverage and control. Both CEE and CIS countries (e.g., Azerbaijan, Latvia, and
Poland) divert substantial resources into off-budget accounts that typically lack oversight and
transparency. These off-budget transactions take different forms, from extra-budgetary funds to
lack of integration of investment planning and external financing into the budget. In the Czech
Republic and several other CEE countries, a further challenge is the significant magnitude of
contingent liabilities stemming from nontransparent off-budget commitments.
Another challenge is to institute the key elements of a functioning budget system that
ensures accountability. Budget formulation is often flawed by ambiguity between executive and
legislative roles, poor parliamentary processes, lack of strategic policy coordination and
consultation, and inability to impose trade-offs at the executive level. Expenditure projections
lack a medium term perspective and revenue forecasts are unrealistic, leading to ad hoc and
nontransparent adjustments during budget execution. Expenditures on defense and internal
security tend to be even less transparent and accountable than other expenditures. Unclear
appropriations and unreliable disbursements often leave public managers unable to deliver
reliable services. They also undermine the accountability of budget managers and undermine
monitoring and evaluation. Progress is being made but it has been slow and sporadic.
Reforms to promote greater accountability and control over budgetary expenditures require
robust accounting and auditing and a strong budget execution process. Treasury systems are
crucial here, and a challenge in many CIS countries and some CEE countries is to bring the bulk
of public expenditures within the accounting and reporting framework of treasury systems.
Investment in information technology-seen in the treasury, accounting, and audit systems in


54
Russia and Kazakhstan-needs to be well grounded in broader institutional reforms. Transparent
and competitive procurement is essential to prevent corruption from inflating public expenditure.
In this context, web-based procurement can be a valuable aid to transparency.
The effectiveness of external and internal audit entities varies greatly. In some countries
such as Kazakhstan and the Kyrgyz Republic, the external audit entity is constitutionally
dominated by the executive, thus limiting its independence and credibility. To be effective in
reducing corruption, external audit must be independent and equipped with strong auditing and
diagnostic skills, moving beyond individual fault to target systemic weaknesses. Internal audit
also needs to be developed further. Parliamentary and public oversight needs to be strengthened,
with public dissemination of audit findings and scrutiny by Parliamentary Audit committees-
which too often do not exist.
Corruption in customs and tax administration lowers state revenues, creates a distorted
private sector environment, and is often linked with smuggling and organized crime. Reforms to
simplify tax policy and eliminate discretionary exemptions help, as do professional staff,
standardization of forms and procedures, and transparent systems such as the use of
computerized risk analysis at the borders. It is important to eliminate one-on-one contact
between taxpayers and officials and ensure that operating and management systems are efficient
and easily monitored, including through periodic taxpayer surveys.
Finally, administrative corruption can be profoundly damaging to the level and quality of
service delivery across key sectors. It is often deeply rooted in distorted policies, as illustrated in
the energy and health sectors. Corruption, for instance, plagues the interface with customers and
lies behind the low collection rates reported by many electricity, gas, and district heating
companies. In Azerbaijan, the state-owned Baku Electricity Company reports a household
collection rate of 12 percent despite employing 1,000 payment collectors. Sale of the distribution
company (Armenia, Georgia, Moldova, Poland, and Ukraine), or privatization/management
contracts (Albania, Azerbaijan, Bulgaria, Estonia, Latvia, Romania, and Russia) can help, as
long as tendering and contracting processes are transparent and contract execution can be
monitored. Reducing noncash transactions including barter and arrears offsets can also reduce
private rent-seeking, as noncash exchange at artificially inflated rates is a standard method of
extracting private gains.
Health services are characterized by interdependence of supply and demand, asymmetric
information, gatekeeper power, divergence between public and private interests and incentives,
and other characteristics that provide fertile ground for corruption. Patients, especially the poor,
are in a uniquely weak position to counter these difficulties. Remedies include a set of reforms in
health care financing, together with complementary measures to reallocate resources to priority
areas, reduce waste in the health system due to malpractice in the procurement of equipment and
pharmaceuticals and a variety of other abuses, and strengthen the professionalism and pay of
health care personnel. Most importantly, health care systems require basic oversight and
accountability (see Box 4.10).


55
Box 4.10: Tackling Informal Payments and Structural Reforms in the Health Sector
Informal payments in the health sector in CEE and CIS are a frequent and growing practice and an impediment to
health care reform. Survey data in 1999 show that informal payments for inpatient care were about US$160 on
average per visit in Kazakhstan. In the Kyrgyz Republic these payments had to be made in about 85 percent of
visits. Solutions to the increasingly entrenched practice of informal payments will need to reach deeply into the
structures of the sector and society:
*     Governments must make clear that side payments and other "off-budget" exchanges between public
employees and citizens are unacceptable and not to be tolerated. Without a clear policy framework that clarifies the
government's position regarding informal payments, it is difficult for a single sector, such as health, to do so.
National perceptions can also be at odds with policy in the health sector. For example, despite national policy
against informal charges, the recently revised Code of Ethics of the Hungarian Medical Association does not
condemn such practices, making them extremely difficult to root out.
*     Existing public health systems are bloated and inefficient. In an effort to retain the largesse of the past in the
face of budget constraints, there has been a bias toward maintaining past facilities without culling assets, personnel,
or services to maximize resource use. The result is a high level of fixed assets alongside inadequate funding for
salaries and equipment, leading to alternative sources of funding among front line providers. Closing down
redundant hospital capacity and reducing overstaffing should offer the opportunity to reduce costs and raise the
salaries of remaining doctors and other medical personnel. In the Czech Republic and Slovenia the number of
physicians has declined somewhat (although further reductions are needed) and their earnings have exceeded or kept
pace with growth in overall wages; side payments to physicians now appear less common than in the other countries
in Eastern Europe. Higher earnings may offer a possible, partial solution at least in some settings. However, this is
unlikely to be a solution in itself. Effective strategies could include voluntary severance pay schemes and
establishment of loan funds to encourage the development of private medical practice, alongside the introduction of
medical standards and disallowance of outdated medical practice by those unable to master basic skills.
*     Governments need to be aware that comprehensive, free services cannot persist in a budget-constrained
environment. In addition to contracting capacity and raising salaries there needs to be an acknowledgement that
government cannot afford everything that is in place. This means either that the scope of services and fixed assets in
use need to be reduced and/or that users be required to cover the costs of some aspects of care.
*     Health systems require oversight and accountability for all providers with swift punishment for transgressors.
Performance is both hard to measure and a new concept in health care. However, achieving a more affordable, fair,
and equitable system requires that relative performance be assessed and that performance benchmarks be set and
providers held accountable for results. Fundamental to this are use of acceptable accounting standards, procurement
rules, and ex-post auditing of hospital accounts combined with tools to ensure that hospital managers comply with
national policies regarding informal payments. Experience shows that the development of professional medical
associations and peer review can help raise standards. Policy statements in the absence of monitoring and
enforcement has proven and will continue to be ineffective in reducing the prevalence of informal payments.
*     Private services are increasingly being seen as alternatives. The weakness of public health services has led to
a search for alternative care, but much of the "private care" is currently either financed partly by government or uses
public infrastructure and equipment to treat private patients. For many countries, especially the poorest, rationalizing
and raising standards in public health services will remain the highest priority. Development of genuinely private
health services will require a framework to regulate and monitor the quality, reliability, and cost-effectiveness of
care, determine issues relating to access, and provide transparent criteria for licensing and monitoring private health
insurance funds.
Based on Lewis (2000).
Decentralization of service delivery can in principle make the state more responsive to
the needs of the people and to improve service delivery. However, in countries where the
accountability and capacity of subnational governments is weak and there are few safeguards
against the manipulation of municipal assets and enterprises for the private gain of local officials,


56
decentralization can actually increase corruption, bias resource allocation, and adversely affect
access and quality in basic social services. This has occurred in parts of Central Asia, the
Caucasus, and Baltics. In many CIS countries, improving accountability at the local level for
local expenditures and to the central government in cases where expenditures are only
administered by the local level (deconcentration) is a necessary first step. Reform efforts should
strongly focus on creating regional/local capacity in financial management and auditing, before
(or while) the decentralization process gets underway.
In parallel with reforms in sector policy and institutions, strengthening public oversight
over the quality of service delivery can promote improvements in certain contexts. In Armenia,
Latvia, and Albania, civil society groups have initiated periodic user surveys of service delivery,
published findings, and ranked public entities according to their efficiency, integrity, and
adherence to service standards. This has provided a powerful impetus for internal reorganization
to realize efficiency gains, develop performance standards, and sow the seeds of transformation
from a command and control orientation to one of service delivery and accountability.
The Multi-pronged Approach
Taken together, the five building blocks of a multi-pronged approach to combating
corruption might appear overwhelming as they entail significant changes in the structure of
existing economic and political institutions, in the nexus of relationships within the state and
between state and society, and in the existing policy practices of governments. No government
has the capacity to simultaneously pursue reforms in all these areas. Moreover, in the transition
countries, the legacies of communism, the underdevelopment of public administration, and the
political constraints holding back reform heighten the magnitude of the challenges.
To be effective, a multi-pronged approach requires some guidelines for the selection and
sequencing of reform priorities tailored to the particular contours of the corruption problem in
each country. Feasible entry points need to be identified. Coalitions of support for anticorruption
efforts need to be assembled. A strategy of operationalizing reforms needs to be developed.
These issues are addressed in the following chapters.


57
The box on political party financing is based on: De Winter (1999), Kaid and Holtz-Bacha (1995), King (2000),
Pujas and Rhodes (1999), and Rhodes (1997).
2 Galligan and Smilov (1999).
3 This section is based on Paul (1999).
4 Although home-grown, many received donor support.
The project is supported by the World Bank and by the Canadian International Development Agency.
6 This section is based largely on Nelson and others (1999).
7 The Glasnost Defense Foundation (www.gdf.ru) maintains a Memorial Book containing the names of 209 news
people who lost their lives performing their professional duties. Cited in Nelson and others (1999).
8 McCormack (1999).
Nelson and others (1999), p. 8.
'o Nelson and others (1999), p. 8.
1 Dow Jones & Co., publishers of the Wall Street Journal, and the Pearson Group, publishers of the Financial
Times, teamed up with Moscow News to create the new daily in 1999. Nelson (2000).
12 See Annex 1.
13 This section draws heavily from Broadman and Recanatini (2000).
14 As determined by the recent EBRD Business Environment and Enterprise Performance Survey, Hungary has one
of the most active governments, ranking 3rd (out of 20 countries) in the State Intervention Index.
15 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.
16 This section draws heavily from Broadman and Recanatini (2000).
17 See Annex 1.
1 See Hellman, Jones and Kaufmann (2000b).


Chapter 5: Designing Effective Anticorruption Strategies
The previous chapter presented a comprehensive set of instruments for combating
corruption. The challenge remains to draw lessons from the typology of corruption for
prioritizing, sequencing, and combining reforms to design the most effective strategy for the
particular contours of the problem in different countries. By unbundling corruption, the goal is to
develop more effective targeting of anticorruption measures to strike at the main sources of the
persistence of corruption. Differentiating the causes and consequences of corruption across
countries should help to set priorities, to identify and evaluate opportunities for entry into serious
anticorruption work, and to develop more realistic expectations regarding the necessary time
horizon of reforms in different contexts. At the same time, designing an effective anticorruption
strategy will always depend upon a detailed understanding of the particular nature of the
political, economic, and social landscape in each country which goes well beyond the simple
typology presented in this report. This landscape will strongly condition the extent to which
different types of instruments will work effectively.
Referring back to the typology presented in Figure 1.5, lessons are identified for each
category of the matrix and illustrated by a box on a particular country which is illustrative of the
dynamics suggested by the typology. A key argument embedded in the typology is that an
anticorruption strategy should be designed not only in response to the level of either state capture
or administrative corruption alone in a given country, but to the interaction of these forms of
corruption as well. Strategies to reduce administrative corruption, for example, need to take into
account the extent of state capture, since the latter may seriously blunt the effectiveness of
conventional anticorruption tools. An effective strategy for fighting corruption should recognize
how the interaction of different forms of corruption enables or limits the state's capacity to
implement necessary reforms.
The typology presents a static picture of the pattern of corruption across transition
countries at a single point in time, but it must be recognized that the pattern of corruption is
much more dynamic. Indeed, in designing an effective anticorruption strategy, it might be more
useful to know in which direction a country is moving within the typology rather than its position
at any given time. The typology does not set out a simple linear path of development. Rather,
countries can zigzag, progressing on one dimension of corruption, falling behind on the other, or
moving ahead on both fronts simultaneously. Steps backward are just as likely as steps forward.
Even in the most advanced countries, the unfinished agenda of structural reform threatens to
exacerbate the problem of state capture. Political regime changes could also cause an abrupt turn
for the better (or for the worse) in particular patterns of corruption. As a result, describing the
potential pathways within the typology as a whole is as important as describing the country
characteristics within each individual category of the matrix.
The typology is presented as an heuristic device designed to enhance our analysis of the
different patterns of corruption and draw lessons for framing effective anticorruption strategies.
It intentionally strives to sharpen boundaries that, in reality, are often far more ambiguous and
complex. As a result, those designing anticorruption strategies will need to examine the
relevance of different categories of the typology for each country based on more information


59
than can be provided in these simple cross-country measures. In this sense, the typology is
intended as a framework for self-assessment of corruption within each country rather than as a
device for providing a fixed reform blueprint for each country in the region. At the country level,
a much further unbundling of the actual practices of and relationships behind administrative
corruption and state capture will be required in order to develop and operationalize an effective
anticorruption strategy.
Medium State Capture/Medium Administrative Corruption
Medium / Medium
Medium State Capture / Medium Administrative Corruption
high medium  medum
Key Focus: Capitalizing on favorable conditions for strengthening
political accountability and transparency through further institutional
reforms
Challenges                          Prorities
*  Risk of complacency and          0  Promote further reforms in civil
backstepping                        service, public finance,
*  Close ties between economic         procurement, and judiciary
interests and political institutions  *  Introduce greater transparency into
*  Cronyism and conflict of interest in  political financing
public sector appointments           Develop strong partnerships with
civil society
Though the countries within this group exhibit lower levels of state capture and
administrative corruption relative to other transition economies, these problems are by no means
resolved in any of these countries. As civil society and the independent media tend to be more
developed in this group, there may be greater exposure and hence greater public recognition of
these problems than in other countries that have higher levels of corruption. The political
consequences of corruption are not necessarily correlated with the level of corruption. Where
political competition is robust and the electorate increasingly sophisticated, complacency in the
face of state capture and administrative corruption has the potential to generate even greater
political instability than it does in less advanced, but more corrupt systems. High-level
corruption scandals, mostly linked to evidence of state capture, have been more likely to bring
down governments in this group of countries than in any of the other groups in the typology.
The corruption challenges faced by these countries are still substantial, both in terms of
state capture and administrative corruption. More robust political competition has not eliminated
the serious gaps in such areas as financial disclosure and transparency of the political process.


60
More direct forms of capture by private payments to public officials have often been replaced by
more discreet, though no less illicit, forms of political party financing. Legislation regulating this
area is poorly developed and weakly enforced in all of these countries (as in many of the
advanced countries of the world). They remain saddled with bureaucracies that retain
considerable discretionary powers to intervene in the market economy. Corruption in public
service delivery continues to be a particularly serious problem.
What distinguishes these countries is not the modesty of the corruption challenges they
face, but the level of development of many of the key institutions and tools necessary to confront
these challenges. These include civil society institutions that are beginning to grow in strength, a
vigorous independent media, an evolving system of institutional restraints within the state,
functioning (if not well-developed) institutions of public administration, and some foundation for
the rule of law. Such institutions are necessary to build and empower the domestic constituencies
that generate sustained demand for combating corruption. They can provide the critical tools of
public monitoring and accountability that are essential for placing constraints on politicians and
bureaucrats. They also underpin a degree of state capacity that enables politicians to assert
greater control within public bureaucracies, if they choose to do so. These institutions are the
essential pressure points and tools to reduce both administrative corruption and state capture.
In many of these countries-Poland, in particular-successful economic reforms have
spurred a vibrant sector of small and medium-sized enterprises (SMEs) and foreign direct
investment that can weaken the concentration of economic interests promoting state capture.
Indeed, competition and market entry can be the most effective means of reducing the economic
rents that underlie state capture.
Yet, even with many of the key constituencies, institutions, and tools to combat
corruption, most countries in this group continue to lack one or more of the following essential
ingredients for an effective anticorruption strategy: political will; collective action; and relevant
technical knowledge and practical experience.
The lack of political will or inability to create an anticorruption coalition, especially at
the highest levels of the political system, have proven to be among the most serious risks to an
effective anticorruption strategy. Political leaders unwilling to kickstart anticorruption efforts by
starting to tackle corruption at the very top breed further complacency at all levels of the state.
Weak collective action from civil society often underscores the complacency of political leaders
to move forward on the remaining economic and political reforms.
While insufficient means and incentives for collective action from civil society are
problems in almost all countries,2 the challenges are compounded in Eastern Europe by
widespread cynicism among the population and a profound lack of trust in the state, even among
the most advanced countries of the region.3 Whether these traits are a legacy of the communist
system or a byproduct of the turbulence and uncertainty of transition, they weaken the pressure
that civil society can place on politicians and bureaucrats to address administrative corruption
and state capture and attenuate the mechanisms of monitoring and accountability that are crucial
constraints on both problems.


61
Finally, even well intentioned efforts in these countries to launch an anticorruption
program can quickly run aground due to insufficient practical experience and technical expertise
to combat corruption. The lessons of historical experience-both positive and negative-have
still not been widely disseminated across the region.
Reducing state capture requires a strategy that goes beyond the classic technocratic
approach. While relatively robust economic and political competition place some constraints on
state capture in these countries, there are still vast areas open to abuse, in particular political
party financing and conflicts of interest. Clear guidelines on financing political parties and
mechanisms to enhance transparency are absolutely essential to channel a key conduit for
informal political influence into more open and competitive forms of political lobbying. The
introduction-and effective implementation-of clear and comprehensive conflict of interest
legislation could also have a powerful impact. Both areas require stronger verification and audit
powers and further judicial and prosecutorial training and reform, worthy areas of institutional
development in their own right. Strengthening enforcement mechanisms is also a feasible
strategy in countries with a stronger framework for the rule of law.
These political leadership and judicial and prosecutorial reforms are needed to back up
what might be called the "traditional approach" to combating administrative corruption. This
approach revolves around the introduction of best-practice technocratic reforms and knowledge
transfers through international partnerships in the critical areas of public administration and
public finance. Elements of such an approach do have the highest chances of success in this
group of countries. Priority should be given to civil service reform, where enhancing training and
compensation levels could decrease incentives for corruption among bureaucrats. Implementing
advanced systems of transparent fiscal management and public procurement administration could
also have a potentially high pay-off for reducing administrative corruption. These reforms should
be well targeted, backed by relevant practical experience, and launched with strong local support
and participation, where feasible. External actors can serve as partners by helping to provide
focus to anticorruption strategies, enhancing collective action among domestic actors, and
providing technical assistance based on international experience, where appropriate.
EU accession can play a major role in pushing these countries toward greater progress.
An active accession agenda can prevent political complacency and generate political will, even
as the reform agenda begins to lose some of its urgency. Technical assistance can also provide
the know-how and partnership to move forward in the most difficult areas of governance.
Nevertheless, experience has already shown that the prospects of EU accession are no uniform
guarantee for all potential candidates of continued progress in structural or anticorruption
reforms.
Despite their many advantages, failure to act decisively to control state capture in these
countries could run the risk of slipping backwards within the framework of the typology. Indeed,
the most likely path of regression in countries with reasonably stronger traditions of public
administration is towards higher levels of state capture. As these economies grow, the capacity of
powerful economic interests to influence fast-developing legal, legislative, and regulatory
frameworks could outpace the constraints imposed by competing interest groups and civil
society. The risk increases in those countries where a major agenda of structural reforms remains
to be completed. The case of the Czech Republic, where a once widely praised mass


62
privatization program was partly undermined by the ability of powerful banks and investment
funds to prevent post-privatization reforms, has been a prominent example of such risks. Further
measures to strengthen political transparency and accountability and to enhance economic
competition are necessary to check the power of emerging commercial, financial, and industrial
groups.
Box 5.1: Poland
Poland has many of the ingredients for a successful anti-corruption strategy-cross-party leadership,
vibrant media, and strong sources of pressure from able NGOs and academic institutes that supply analysis
and advocacy. With a few prime exceptions-such as adequate laws on political party financing and rules
to constrain lobbying-many of the laws needed already exist. Further ingredients needed are commitment
to transparent implementation, together with sustained reform of parliamentary, judicial, and prosecutorial
agencies and the public administration. As yet, strategic direction and focus, which the newly formed High
Level Group may be able to bring, are somewhat lacking.
The Minister of Justice launched a Clean Hands campaign in 1994, but effective implementation did not
materialize. More recently, Parliament has set up ethics and disciplinary committees and the Parliamentary
Committee on Internal Affairs has published a report on corruption focusing primarily on enforcement
issues. The Supreme Audit Chamber has supplied sustained leadership with a plethora of highly critical
reports but with little follow-up from parliament, government, or prosecutors. Several regional governors
are attempting anticorruption campaigns, with mixed success. A small number of key politicians keep
anticorruption issues in the public eye, bolstered by a continuing flood of newspaper articles and television
programs.
Reforms such as the recent Law on Economic Activity are intended to reduce the opportunities for
corruption at the interface between public and private sectors. The new Civil Service Law is designed to
combat the politicization of appointments and build a career civil service of integrity. If these laws can be
successfully implemented, they will go far to lift the burden of corruption from the private sector and
strengthen state institutions against corruption. A law on political party financing now on the drawing
board promises to make inroads into state capture, as would effective implementation of the existing law
on conflict of interest and financial disclosure.
Despite Poland's strong commitment to state-building and the market economy, close links between
economic interests and political institutions continue. A particularly damaging feature is cronyism and
conflict of interest in appointments to regulatory authorities, boards of privatization commissions, state-
owned enterprises, and extra-budgetary funds. Public service appointments are also highly politicized,
exposing some appointees to a corruption levy as well as inflicting loss of expertise and institutional
memory in the poorly paid administration. High-level corruption is also manifest in interference in customs
and in the award of tax exemptions, concessions and licenses, and malpractice in public procurement.
Administrative corruption at the subnational government level remains problematic, particularly in
transactions involving land and assets and in procurement. The health services are marred by procurement
abuse, corruption at the interface between hospitals, doctors, and the pharmaceutical industry, and
extraction of informal payments. The deep distrust of the state that characterized the Soviet period
continues to weaken the credibility of anticorruption efforts.
Based on Sutch, Wojciechowicz, and Dybula (2000).


63
Medium State Capture/High Administrative Corruption
Medium / High
Medium State Capture / High Administrative Corruption
high  meuum medm
conup6on
s  c
Key Focus: Enhancing state capacity to improve the provision of basic
public goods.
Challenges                          Pioities
*  Highly underdeveloped public        Build the capacity of public
administration                      administration
*  Lack of control and accountability  0  Develop instruments for financial
within the state                    management
*  Nascent civil society            *  Encourage civil society
development
The key feature of most of the countries falling into this category is the weak capacity of
existing state institutions, both in terms of the provision of basic public services and regulatory
functions and the existing mechanisms of accountability and control within the state apparatus.
In extreme cases, civil unrest or war has threatened the state, such as in Albania and Armenia.
Administrative corruption thrives in such an environment and often reaches the highest levels of
the political system. At the same time, corruption at the household level can be particularly
problematic, affecting the delivery of most public services.
In such countries, anticorruption efforts should be synonymous with fundamental state-
building. This entails, first and foremost, developing the capacity of the state to deliver basic
public goods, such as public order and stability, health care and social protection, and simple
systems of public revenue management. Enhancing the capacity of basic institutions of public
administration and the civil service is necessary, but this should be combined with liberalizing
measures to reduce bureaucratic discretion in the economy.
State capture by firms as measured by the BEEPS survey does not appear to have reached
the highest levels in comparison with other transition countries. However, this may be due not to
any greater degree of constraints on state actors (as in the group of countries discussed above),
but to a less concentrated economic structure (such as a predominantly agricultural economy) or
to the overall lack of state capacity to intervene in the economy. There are also other forms of
state capture, such as by public officials themselves or by specialized state sectors (e.g., the
military) that may be relevant in individual cases, but are not measured in the BEEPS survey.


64
In Kazakhstan, for instance, corruption appears to be relatively higher in a small number
of high-revenue sectors, though not a general issue confronting all firms across the board. As the
state capture index in the survey measures the proportion of firms affected by state capture, the
score is relatively lower than in other transition economies. Moreover in Kazakhstan, regional
and local officials are directly negotiating with firms. These actions do not involve sale of laws,
are characterized by greater predictability and certainty (which also lowers the frequency and
amounts of bribes that firms have to pay), and entail minimal high-level micromanagement of
day-to-day administration. As a result, firms are less likely to try to buy laws, decrees, and
regulations at the highest levels of the political system, accounting for the relatively lower level
of measured state capture.
Civil society in these countries may be particularly weak; clans or other informal ties can
lead to social fragmentation in some cases. Consequently, there are unlikely to be strong social
constituencies to demand and sustain an anticorruption program. The knowledge gaps on the
causes and consequences of corruption, as well as on strategies to combat the problem, can be
wide. Public education and awareness are particularly critical elements of any anticorruption
strategy in these countries, as the constituencies for reform within civil society are unlikely to
have the capacity to sustain the demand side for anticorruption activities.
Political will to combat corruption is most likely to be driven by external pressures,
especially international donors. Donors tend to play an important role in these countries,
assisting in the process of state-building. Creating safeguards to ensure and monitor effective
delivery of donor assistance is likely to be a priority in some countries and could be an important
entry point toward a program of further institutional reforms. (See Box 5.2 on Albania and Box
5.3 on post-conflict environments.) Yet such a program should have clearly defined and limited
goals, as the task of state-building will have a long time horizon.
Perhaps one of the most serious problems in this group of countries is the looming threat
of higher levels of state capture. Indeed, the risk of moving toward the "high-high" category in
the typology would appear to be greater than the likelihood of progress toward the "medium-
medium" category described above. As the private economy develops and gathers strength, there
will be strong incentives for these actors to engage in state capture. Paradoxically, stability could
carry greater risks of state capture by private firms, as the influence of other important
constituencies, such as the military, begins to subside.
If economic reforms move forward in these countries, it will become critical to
incorporate measures to ensure competition and weaken potential vested interests in order to
prevent state capture from developing into a serious challenge.


65
Box 5.2: Albania
Albania was one of the most isolated countries in the world and certainly within Europe during the
communist period. It also remains the poorest country in Europe. Located in close proximity to Italy and
Greece, expectations were high after the country opened up in the early 1990s, and with substantial external
assistance, a quick transformation into an open economic system took place. However, public institutions
and oversight mechanisms could not keep pace. Civil society, including the private sector community and the
press, was extremely underdeveloped and authority remained highly concentrated. Simultaneously, progress
in putting in place institutional restraints in the political system and ensuring judicial independence has been
moving ahead, but very gradually.
The close proximity to Europe generated donor support but created problems as well. Weak state structures
allowed criminal activity to flourish, using Albania as a transit platform to reach Europe. The collapse of the
pyramid schemes in 1997-after they had enriched many high-level political figures-wiped out the life
savings of the poorest Albanians, led to major civil disturbances, and cemented the public's distrust toward
public institutions. A vicious cycle has emerged in which corruption acts as both a cause and a consequence
of a chronically weak state and weak public institutions.
Following the 1997 disturbances, a newly elected government launched an anticorruption initiative with
donor support. Surveys of public officials, enterprises, and households and a comprehensive government
anticorruption action program were developed and presented in a public workshop in mid-1998. The surveys
were instrumental in raising the profile of corruption and shaping the terms of debate. Perhaps for the first
time, the domestic media-which provided extensive coverage-turned to discussing institutionalized
corruption rather than scandals involving individual public figures.
The government's program was broad and comprehensive, including more than 150 specific measures in the
areas of economic policy, rule of law, public administration, procurement, audit, and public awareness.
Implementation of many of these reforms has been driven by donors, partly because donors wanted to assure
themselves that their assistance would be effectively utilized. However, this combination of reliance on
foreign assistance and weak state structures has expanded the role of donors; domestic ownership and
sustainability of the reforms needs careful nurturing.
Implementation of the program to date has been mixed at best, due to a variety of factors. The political
leadership itself was not free from charges of corruption. The public sector was one of the only sources of
patronage for the newly elected Socialist Party coalition creating political constraints on reform. There was
no unbiased forum of "last resort" since enforcement agencies and the judiciary were incapable of
functioning properly and were themselves burdened by allegations of corruption. Moreover, ownership of the
program has diminished over time. The Prime Minister changed three times in a two-year period. Most
recently, a revised Anti-Corruption Action Plan has been announced, updating the measures and improving
implementation-monitoring mechanisms. However, given the experience with the first effort, skepticism has
begun to set in.
On the positive side, public administration reform finally began to move forward in mid-1998, due to a
combination of domestic interests and international donor pressures and assistance. Civil service reform is
moving ahead and an outreach program is under way to explain the new process to public officials, local
governments, and others. NGO-organized roundtables have helped to broaden the circle of those
commenting on the draft law.
Other reform measures have focused on improving financial management. Computerization of the treasury,
improvement of accounting procedures, improvement of budget preparation, and internal audit reform are
ongoing. One of the most important areas currently being addressed is customs, the main revenue source and
considered to be one of the most corrupt entities. A new customs code and implementing regulations were
adopted. Customs and tax revenues are up significantly. Reforms in the judiciary and enforcement agencies,
institutional in nature, are only slowly showing results.


66
High State Capture/Medium Administrative Corruption
High / Medium
High State Capture / Medium Administrative Corruption
high  hedium  medium  mkdadhWv
co-nup
Key Focus: Enhancing political accountability and promoting new entry
to take maximum advantage of a stronger legacy
of state capacity
Challenges                           Piotities
*  High concentration of power       *   Broaden formal channels of
by vested interests                  access to the state
*  Weak structures for monitoring    *   Deconcentrate economic power
and accountability                   through competition and entry
*  Powerful groups block further     *   Enhance oversight through
reforms to preserve their            participatory structures
advantages
Countries with high levels of state capture alongside medium levels of administrative
corruption generally benefit from a historical legacy of the rule of law and well-developed public
administrations associated with previous, pre-communist regimes. However, their problems with
state capture are rooted in either high concentrations of economic power in key industrial sectors
(such as gas and oil transit and agribusiness in Latvia) or weakly accountable political regimes
built around populist or nationalist politicians with close ties to powerful enterprises (such as the
first governments after independence in Croatia and the Slovak Republic). State capture can be
seen as repressing the advantages that these countries have in terms of the capacity of the state
and the strength of public administration. Reducing state capture could thus unblock a powerful
potential for further reforms.
In these countries, the major obstacles to further progress on structural reform lie less in
the weak capacity of state institutions than in the power of vested economic interests and the
private interests of powerful politicians. Though basic political institutions and civil society are
much more developed in this group compared with the previous one, mechanisms of
accountability tend to be attenuated in these regimes. Political access for competing interest
groups is often blocked. Institutional restraints within the state are generally weak. Political
contestability is less robust than in countries of the medium-medium group. Consequently,
conflicts of interest abound in some countries as political leaders can equate their private well-


67
being with the country's well-being. Favored firms develop close ties to politicians and their
parties, often blurring the boundaries between the party and the firm.
The major challenge in these countries is to break the political stranglehold on further
progress in reform. Combating state capture should become the key focus of any anticorruption
strategy. Though technocratic reforms might be useful as entry points into anticorruption work, a
credible reform program should be designed to broaden formal channels of political access and
to increase the accountability of political leaders to a wider range of constituencies. Encouraging
the development of institutional mechanisms of political oversight and promoting transparency
in party financing could also have a positive impact. Efforts to promote collective action among
anticorruption constituencies and competing interest groups (such as SMEs, trade associations,
and professional societies) should play an important role in an anticorruption strategy. In
sequencing an anticorruption strategy, the early promotion of political reforms and partnerships
with civil society has the potential to achieve a considerable impact.
At the same time, where powerful monopolies are the prime force behind state capture,
emphasis should be placed on deconcentration, competitive restructuring, and reducing barriers
to entry. In countries such as Latvia and the Slovak Republic, the generally fast pace of
liberalization throughout the economy slowed considerably as it reached the door of some key
sectors in the economy, creating rents to particular firms through anticompetitive barriers
maintained through state capture. Continued progress in privatization coupled with particular
attention to corporate governance standards and regulatory reform are essential for
deconcentrating economic power and breaking existing networks with the state.


68
Box 5.3: Post-conflict Environments
Although the Cold War ended peacefully for most countries of the former Soviet bloc, some countries and regions-
Tajikistan, the Caucuses, the Balkans-found themselves embroiled in civil wars and territorial conflicts as the
political map of the region was redrawn. While the recommendations embodied in this report are generally
applicable to all transition countries, with relevant emphases adjusted to reflect the typology of corruption in each
country, the political and social dynamics in post-conflict countries pose particular challenges for reducing
administrative corruption and state capture.
The real wars that erupted when the Cold War was in demise were mostly centered around ethnic or regional
divisiveness, or extreme nationalism, a fact that bears directly on both our understanding of corruption and the
development of strategies for post-conflict countries. First, corruption served-and in some cases continues to
serve-as a vehicle diverting state assets to promote conflict and maintain power structures. Second, the strong
rhetoric of nationalist regimes exploited the fears of the population and rendered corruption to be a distant concern,
at best. In some cases, the hard-line approach of nationalist regimes effectively silenced government critics and civil
discourse, both of which play important roles in reducing corruption.
Post-conflict countries face unusually harsh public finance challenges. Domestic revenue collection systems are
highly fragile and nontransparent and inefficient expenditure practices provide fertile ground for the diversion of
public resources for private use: (i) tax collection mechanisms are notoriously weak in post-conflict countries-
often tax instruments need to be created, or the ad hoc wartime tax regimes reformed; (ii) borders have often
changed (or changed hands) with conflict and remain porous in aftermath, with weak border controls; (iii) budget
management is weak (or even nonexistent in "new" states) and may indeed be captured by the dominant nationalist
powers; (iv) treasuries, audits, and public disclosure of financial information are often nonexistent in post-conflict
settings, either because the pre-conflict structures have been destroyed, or because they never existed.
Rebuilding the physical infrastructure of war-torn economies, particularly in the Balkans, has largely relied on huge
inflows of aid. The size of the investment projects and the large sums of money involved require particular emphasis
on internal controls and sound financial management to ensure that de facto fungible resources are put to proper use
and not siphoned off through corruption and waste. The Stability Pact Anti-Corruption Initiative for South East
Europe calls for priority measures including:
* Taking effective measures on the basis of existing relevant international treaties and agreements;
* Promoting good governance, through legal, structural, and management reforms for better transparency and
accountability of public administrations, through development of institutional capacities and through
establishment of high standards of public service ethics for public officials;
* Strengthening legislation and promoting the rule of law;
* Promoting transparency and integrity in business operations;
* Empowering civil society and independent media to galvanize community action and generate political
commitment.
More broadly, the regional development strategy5 prepared for the Stability Pact emphasizes the key role that
development of sound institutions and governance must play in order to effectively implement regional initiatives
and policies. Three key sets of institutional reforms-improvements in budget formulation and execution,
improvements in public administration and civil service, and reform of legal and judicial systems-are highlighted
as necessary for improving service delivery and policymaking. The strategy further outlines how robust measures of
governance improvements can be used to provide governments with incentives to reform.
While the anticorruption challenge for post-conflict societies is immense, so are the stakes. In the Balkans alone,
there are some 1.7 million refugees and displaced persons, and production remains at levels 25 percent below
pretransition levels. Efforts to rebuild such economies will be undermined if corruption is not kept firmly in check.


69
It is in this group of countries that an internal change of political regime can open up the
greatest opportunities for implementing a comprehensive anticorruption strategy. The legitimate
transfer of power from a once firmly entrenched ruler or dominant political party holds out the
possibility of breaking or otherwise reorienting the ties between established political leaders and
powerful economic interests. Regime change is often accompanied by a resurgence of political
competition, a strengthening of political parties, and a rejuvenation of civil society that can
increase accountability pressures on the new political leadership. This creates a valuable political
window of opportunity to promote an anticorruption strategy that strikes at the root causes of the
problem (for further discussion of windows of opportunity, see Box 5.4)
Box 5.4: Windows of Opportunity in Croatia and the Slovak Republic
Both Croatia and the Slovak Republic entered the transition as parts of larger states that were among the more
advanced in Central and Eastern Europe. The first post-independence governments in both countries were centered
on the theme of nationalism and a much higher degree
of concentration of political power that may have
contributed to the relatively higher levels of state      When was Corruption Worst
capture than that found in their neighbors, Slovenia               Slovakia?
and the Czech Republic. While the challenge of               Opinions of Enterprises
unraveling the systems that developed is a daunting  50
one, recent changes of government present valuable   40
windows of opportunity in both countries. In the
Slovak Republic, the coalition that was elected in late  _
1998 has placed anticorruption and institutional     0
reform high on the policy agenda, developing a
comprehensive anticorruption program, passing a
sweeping public administration reform, and proposing    before  1990-   1994- sincethesamein
freer access to state information. A recent survey       1989    1993   1998   end of all those
suggests that, while bringing corruption under control                          1998  periods
will take time, there is some indication that perceived
levels of corruption have fallen. In Croatia, the change  Source: World Bank
of power has been much more recent. The erstwhile
leader's death in late 1999 and his party's defeat to moderates in the January 2000 elections have generated an
atmosphere of openness that was unknown in the earlier regime. It remains to be seen whether the new government
in Croatia will take advantage of the current window of opportunity to advance a proactive anticorruption agenda.
In the absence of a political breakthrough, continuing efforts to strengthen ties with civil
society, build allies with interested anticorruption partners within the state, enhance transparency
within the political system, and foster economic competition all have a potentially high pay-off
by strengthening internal pressures for reform. Such measures lay a strong foundation for a
credible comprehensive anticorruption strategy if the opportunity arises.
By tackling the problem    of state capture, these countries have high potential to shift
toward the medium-medium cell in our corruption typology, joining the other countries of
Central Europe that have enjoyed similar advantages in terms of a legacy of stronger state
capacity and high levels of development. Again, EU accession can play an important role in
increasing the pressure to unblock the key political obstacles to further reform. Partnerships and


70
knowledge transfers, especially to promote collective action in civil society and strengthen
competing economic interests, are also essential.
However, failure to constrain and reduce state capture could lead to further regression
and the erosion of existing state capacity and the control functions that have kept administrative
corruption in check. The prolonged use of corrupt incentives to influence policymakers and
administrators leads to diminishing confidence in public servants and state institutions. Such a
low level of trust in the conduct of public officials generates further incentives to secure access
by using officially proscribed means, which further weakens the accountability and legitimacy of
the political system. As formal means of access decline, informal networks are strengthened to
gain access to privilege. Growing informality also weakens revenue collection, limiting the
resources available to build a professional civil service. As police and other enforcement
agencies become clients of powerful individuals and economic interests, alternative means of
recourse are sought, resulting in the use of informal and often violent means to enforce contracts
and settle disputes. Consequently, state capture can eventually erode state capacity, despite
favorable legacies from the past, and generate increased levels of administrative corruption as a
result.
Box 5.5: Latvia
State capture is significant in Latvia, where the economy is highly concentrated, political parties are closely
aligned with economic interests, and the country's position on east-west trade and energy transit routes exposes it
to strong corruption pressures. Parliament's adoption in 1995 of a conflict of interest law signaled the
significance of these issues. But this parliamentary initiative languished until 1997 when the Prime Minister
convened the first anticorruption workshop. The effort deepened with the establishment later that year of a high-
level Corruption Prevention Council (CPC) chaired by the Minister of Justice, and in early 1998 the cabinet
approved a balanced strategy focusing on prevention, enforcement, and education. At this stage some
understanding at high levels had been achieved but there was little readiness to tackle vested interests,
bureaucratic inertia remained strong, and the strategy had little or no public credibility.
The Minister of State Revenue led the first stages of implementation of the new strategy, focusing on the actions
needed to give teeth to the conflict of interest law and commissioning an assessment of vulnerability to
corruption in Customs and the tax administration. The Minister of Finance is following up with a project
designed to strengthen transparency and efficiency in management and operations. Recent taxpayer surveys
indicate that taxpayer satisfaction is starting to improve-the first demonstrable results.
In a further crucial step the cabinet expanded the program outside the confines of government, releasing the
strategy for public discussion at a conference in June 1998 that was broadcast throughout the country and
attended by representatives of NGOs, universities, and the business community. The CPC broadened its
membership to include participants from civil society and commissioned diagnostic surveys of households,
businesses, and public officials.
The government is now launching a broad governance program ranging from elimination of bias in the
allocation of cases to judges to infrastructure regulation to reform of pay and incentives in the public
administration. The powers of the road police have been redefined. A draft law to bring financial discipline and
accountability to the proliferation of public agencies is on its way through Parliament and measures to cut abuse
of licensing and inspections are in the pipeline.
Despite undoubted progress under the Latvian program, the public is not satisfied by the limited improvements
that it can perceive so far in public services. Public discussion focuses on the need to clean up political party
financing and to implement the conflict of interest law in a more convincing way. Efforts to reduce state capture
will need to complement administrative reforms if the strategy is to become fully credible and sustainable.


71
High State Capture/High Administrative Corruption
High / High
High State Capture / High Administrative Corruption
Inugh
high  medium medium  n id
com;pon
,tate capAne
Key Focus:     Breaking the hold of vested interests on the process of
policy and institutional reform
Challenges                           Profities
*  Highly concentrated economic      *  Deconcentrate economic interests
interests that can block reforms     through restructuring, competition
*  Limited implementation capacity of   and enhanced entry
government                        0  Build accountability and
*  Poorly organized anticorruption      oversight mechanisms
constituencies                       Promote collective action
.  Restricted channels of access for    among countervailing interests
countervailing interests          *  Stand-alone technocratic reforms
will have limited impact
Where state institutions with weak administrative capacity co-exist with a high
cocentration of vested interests and a state highly susceptible to capture, the problem of
corruption is particularly challenging. Powerful private interests have the capacity to block
institutional reforms that would limit their capacity to extract rents from the state and eliminate
market distortions that work to their advantage. The government lacks sufficient mechanisms of
control and accountability throughout the state bureaucracy to implement institutional and policy
reforms. Underdeveloped civil societies and intermediary associations do not yet exert sufficient
pressure on politicians to counterbalance the weight of concentrated vested interests. The
credibility of government on corruption issues is likely to be very low. In short, the interaction of
state capture and administrative corruption makes this the most difficult environment to design
an effective anticorruption program.
As the status quo benefits powerful interests, the political economy of anticorruption
initiatives in these countries is particularly complex and difficult. Capture has distorted the
formal and informal rules of the game to encode the advantages of particular groups into the very
framework of the new institutional environment. The persistence of corruption in these countries
has been supported by institutionalized incentives, networks, and relationships.


72
Stand-alone efforts to tackle administrative corruption through technocratic reforms in
public administration and public finance are likely to have limited impact. Indeed, experience to
date suggests that anticorruption strategies limited to technical reforms with fairly standard
instruments have failed to produce the desired results. For example in Georgia, efforts to create
enclaves of technocratic reforms in the civil service, the Ministry of Finance, and in the area of
external audit have proven unsuccessful. The institutional context is as yet too weak in these
countries to deliver the minimum necessary underpinnings for such reforms. Given the low level
of organization of civil society and constricted formal channels of interest intermediation for
countervailing social groups, such efforts are unlikely to prove sustainable over time (for an
example, see Box 5.6 on Azerbaijan).
Box 5.6: Azerbaijan
Resource-rich Azerbaijan has a highly concentrated system of political power with limited institutional restraints
on the executive. While the president has extensive powers, other institutions such as Parliament and civil
society are relatively weak. The judiciary is not perceived to be sufficiently independent. The press and political
opposition are subject to extensive controls. There is still very little separation between economic and state
interests, especially in the strategically important energy sector.
In late 1998 the government began to put anticorruption on the agenda. This was seemingly due to external
pressures: multilaterals and bilaterals have been increasingly withdrawing support, businesses are moving out,
and levels of FDI have been less than expected. The issue has been raised in high-profile conferences and round-
tables. Newspapers have started, for instance, to report on corruption (including high-level corruption).
Opposition parties have become more outspoken.
In a resource-rich country like Azerbaijan, it has become obvious that a credible anticorruption strategy will first
of all have to address the close ties between economic and political interests, especially in the energy sector,
which afford opportunities for illicit private gains from the control of the profits and revenues. This implies the
need for greater transparency in the transactions of the state oil company (SOCAR), budgetary control and
transparency of revenue flows into and out of the government oil fund, and the restructuring of SOCAR itself.
Several international institutions have pressed for these measures as preconditions for further support. They
serve as a means to assess the credibility of the government's commitment to fighting corruption.
The government has stated its desire to embark on reform of public administration, financial management, the
judiciary, and the legal system. The approach so far, however, has been piecemeal. There has been resistance to
implementing stringent measures. Decreasing the powers of the Cabinet of Ministers, eliminating illicit
influence in judicial and civil service appointments, reducing prosecutorial powers, and subjecting executive
actions to external controls-these suggested reforms have been lightning rods for opposition from powerful and
entrenched beneficiaries of the existing system.
In such environments, pursuing reforms that target state capture should also be the key
priority. This requires measures on two fronts: increasing the costs to politicians of state capture
and decreasing the gains to captor firms deriving from state capture. On the costs to politicians,
the weakness of civil society and low level of institutional restraints within the state suggest that
efforts should begin with building credible constituencies in and outside the government to bring


73
sustainable impact. Moreover, given the low level of the state's capacity, the implementation of
reforms to increase government accountability is likely to be inconsistent at best. A ray of hope
in Georgia has been the work done by the agency for declaration of incomes and assets of the
highest public officials, often amid adverse and financially difficult circumstances. This agency
has made publicly available the declarations of more than 1,000 high public officials.
In light of the political constraints, a potentially greater impact could come from
decreasing the gains from state capture to the captors. This would entail a focus on
deconcentrating vested economic interests through competitive restructuring of monopolies,
reducing barriers to entry, and increasing transparency in corporate governance. However, these
reforms are likely to encounter substantial political resistance from those who gain from such
distortions. Breaking the political stranglehold of concentrated economic interests on the reform
process requires efforts to foster collective action among potential countervailing interests, such
as "second-tier" companies and small- and medium-sized enterprises, to obtain political access.
This could entail the development of business and trade associations and formal lobby groups to
increase the range of interests with access to government, to foster competition in an effort to
reduce the concentration of existing rents, and to strengthen formal and transparent channels of
influence. The recent formation of the 2015 Club in Russia, which unites businesses that are
committed to working together to promote higher standards of corporate behavior, is a promising
development. With a greater number and diversity of economic actors competing through more
open conduits of political access for a limited pool of rents, the gains from capturing the state for
individual firms could be substantially reduced. In terms of sequencing reforms, these measures
should be given the highest priority, especially in light of the poor initial prospects for the reform
of political institutions.
In developing an anticorruption strategy in these countries, it is critical to search for a
feasible entry point to break the obstacles that prevent further reforms. When the challenges are
substantial and the institutions needed to deal with them are weak or compromised, finding an
operational strategy that can achieve some demonstrable changes in a reasonable time frame is
particularly difficult. Anticorruption programs should be designed around achievable "litmus
tests" to gauge the government's commitment to reform and to recognize the limitations in such
environments. Efforts to build up demonstration effects through intensive work with carefully
selected organizations, sectors, or regional authorities might provide a method of entry into
broader anticorruption work.
Whatever the approach, expectations should be limited and the time horizon of reform
must be considered quite long. Though occasional windows of opportunity for reform might
arise, it is crucial to recognize that the extent of state capture, the concentration of economic
interests, and the institutional weaknesses of the state will serve as powerful constraints on the
effectiveness and sustainability of reforms introduced through such windows. Unlike the
countries in the high-medium category of the typology described above, windows of opportunity
should not be used to introduce comprehensive anticorruption programs, since the inevitably
poor implementation at later stages will undermine the already limited credibility of
anticorruption efforts. Instead, opportunities should be seized wherever possible to push for the
deconcentration of economic power, enhanced citizen voice, and political accountability to begin
to weaken the underlying causes of state capture in these countries.


74
Box 5.7: Russia
Russia began the transition with a president and prime minister oriented towards reform, but without the
institutional safeguards deriving from a strong Parliament, judiciary, civil society, and system of public
administration. The gradual liberalization and de facto decentralization of property rights to incumbent managers
during the era of perestroika and the considerable rent-seeking opportunities in the early stages of transition led
to the creation of highly concentrated economic interests, especially in the natural resource and financial sectors.
Partly as a result of their influence, the privatization process tended to exacerbate the concentration of power
leading to the emergence of large financial-industrial groups who, in turn, have successfully lobbied the state for
special privileges and opposed further reforms to create a more competitive environment. Such powerful vested
interests present formidable obstacles to policy and institutional reforms that are crucial to reducing state
capture, such as introducing greater entry and competition in the natural resource sector and greater transparency
in government.
The challenge for Russia's new government is to find ways to break the stranglehold of these concentrated
vested interests over the functioning of the state. An important first step is to reduce the power of energy
producers over the state and to deal decisively with the problem of non-payments in the sector. Other important
steps include introducing transparency in decisionmaking within the government and strengthening the capacity
of civil society to monitor the government's behavior.
Civil society appears to be emerging as a potential force to fight corruption. The National Anticorruption
Committee-an NGO chaired until recently by former Prime Minister Sergei Stepashin with formidable
membership from political parties to the right, center, and left-was formed in October 1999. The Committee
has begun monitoring corruption in Russia, and appears to be playing a decisive role in formulating the strategy
of the Duma's Anticorruption Commission.
A number of subnational governments are undertaking systemic reforms to limit opportunities for corruption. An
example of such a municipality is Obninsk, a city of 110,000. Obninsk has tried to create a transparent local
government through citizen participation. With some help from external grants, Obninsk has developed a
miniconstitution that declares the community's right to voice opinion. One novel example of transparency by the
local government in Obninsk relates to the budget process. While developing the budget, the city administration
puts the draft on an internet website. By doing so, the administration encourages comments and input from the
community. Additionally, the government puts up on the internet the budget for the previous year. On a pilot
basis, public goods are being procured over the internet. Not only can local administrators easily access this
information, but the community is encouraged to come to city hall and use one of the general computer terminals
to check up on such information as well.
Implementing an Anticorruption Strategy
Though the typology of corruption presented above provides a framework for tailoring
individual anticorruption strategies to the particular pattern of corruption in different contexts,
there are a number of cross-cutting principles that can be essential in operationalizing an
effective strategy. They provide an operational framework for gaining a foothold to begin
anticorruption work, building credibility behind an anticorruption strategy, and enhancing the
sustainability of that strategy over time.


75
Common strategic challenges
The first challenge that all transition countries face in launching an anticorruption
strategy is credible leadership. A serious anticorruption program cannot be imposed from the
outside, but requires committed leadership from within, ideally from the highest levels of the
state. Yet it is precisely the credibility of the state that is undermined by pervasive corruption,
creating a potential vicious circle in which entry points for an anticorruption strategy are hard to
find. Where presidents or prime ministers are unwilling to take up the challenge, leadership in
strategic areas can come from a determined minister with the clout and resources to launch
reforms in his or her area of responsibility or from a regional executive committed to change in a
particular locality.
The second challenge is finding an appropriate entry point for anticorruption work.
Given the magnitude of the tasks faced in most of these countries, it is critical to begin at a point
where the goals are feasible and tangible results can be realized within a time frame that builds
support for further reforms. Small gains can provide essential levers to sway public and official
opinion. Entry points should be chosen to tackle high profile problems that respond to public
opinion or business dissatisfaction.
The third challenge is to develop a detailed diagnosis of the nature and extent of
corruption in the particular country. Experience has already shown that domestic surveys of
households, firms, and public officials can be a powerful tool in any anticorruption strategy (for
a more detailed description of previous experience see Box 5.8). The purpose of such an exercise
is to gain essential information about the nature of the corruption beyond the general categories
analyzed in this report and to identify possible entry points (see below) into effective
anticorruption work. The process of implementing surveys, running workshops, and developing a
dialogue within civil society on the nature of the problem can play a major role in galvanizing
support for an anticorruption strategy and building constituencies at various levels of the system.
Assessment of the political culture6 is the fourth challenge, in order to evaluate
incentives and disincentives for change that will condition the feasibility of particular
instruments of reform and the way they can realistically be sequenced in a particular country.
Political culture relates to the way authority is exercised, and the extent to which power is
narrowly concentrated or, alternatively, is disseminated across different institutions. It is also
manifest in the way accountability mechanisms operate, whether through clientelism, such that
the official feels accountable to a political patron or senior family member, or according to
explicit rules. A further important component of political culture relates to the degree of trust
that people feel in their institutions and in each other. Trust is also an important determinant of
social capital and the capacity of communities to coordinate their efforts and act as effective
participants in an anticorruption strategy.


76
Box 5.8: Diagnosing the Problem
One of the most vexing problems in developing an anticorruption strategy is figuring out where to begin. In many
countries, gaining political momentum, generating public support and pressure for reforms, and identifying priorities
have been furthered by the use of "anticorruption diagnostics." The diagnostics-at times supported by foreign and
multilateral aid and at other times homegrown initiatives-include detailed surveys and public opinion polls, focus
group discussions, and sectoral assessments. Diagnostics can provide a wealth of information, such as identifying
the forms of corruption that officials feel are most prevalent (e.g., in the chart on Albania,7 below) and the overall
composition of unofficial payments made by enterprises (e.g., Georgia). Even in countries with relatively lower
levels of administrative corruption, diagnostics show, for example, the impact that unofficial payments have on the
poor and the link to small-scale business activities (e.g., Latvia), and the importance of mcritocratic personnel
policies (e.g., the Slovak Republic).
Common Forms of Corruption in Albania            Enterprise Unofficial Payments in Georgia
theft of state assets                                                    A . tc Is
3%     Senitarinspeon
bribery in procurement                                                        Pho   the instln
Bed:, o g  t           [P5 Ie.)
embezzlement of          I                               Custm
donor funds                                             a                   ElecIally conmnies
"speed" money
bribery for monopoly
power                                                                       z
embezzlement of                                                                17%
public funds                                             inpe1on by  or
flNcW mAme"
0       10       20      30      40                  22%
percent of public officials
Impact on Households in Latvia                 Corruption and Meritocracy in Slovakia
100%       -
75%-
per..entf ncm                                                            scorruplion is rather or very
paid in I~b..                                                               widespread
50%  -Ocorruption is not widespread
lcorruption is non-existent
25%
ri.h..t  b0%e44.
.Iddl. 5      lh-.. iftie
mnm,-              0%
bein...                   LOW     MED      HIGH
meritocracy  mentocracy  meritocracy
The use of diagnostics builds on the philosophy of transparency and accountability that is the key foundation for
developing a sustainable anticorruption strategy. Yet, the information provided must be supplemented by other
forms of expert analysis and review in order to gain a comprehensive picture of corruption in a given country.
Source: World Bank.
The final challenge is maximizing leverage beyond the entry point. This depends on
framing reforms to appeal to the incentives influencing important actors. Efforts should be made
to design "win-win" anticorruption strategies that promote the interests and reputations of major


77
politicians and businesspeople while delivering positive externalities such as enhancing
economic growth, strengthening governance, or reducing poverty and inequality.
Sequencing
There is no simple formula for the proper sequencing of anticorruption reforms.
Sequencing should be developed in response to the particular constraints identified in each
country. Nevertheless, proper sequencing should be designed to enhance the credibility of
leadership and to ensure early tangible results to strengthen the constituency for reform along the
way.
In some countries, the credibility of an anticorruption strategy may rest on the capacity of
the political leadership to make an initial, highly visible, and substantive change at a high level.
This acts as an indicator of commitment at the top as well as a signal for those at lower levels
that their behavior must change. In other countries, efforts to tackle state capture head-on at an
early stage might be impossible or even dangerous for those involved. The only possible entry
points, and the only potential early wins, may be in a particular sector, such as education, which
is unlikely to invoke the wrath of powerful economic interests. Yet even in these cases, measures
to tackle state capture and strengthen accountability cannot be postponed too long or their
absence could ultimately undermine the credibility of both the strategy and its leadership.
Throughout the region, the first impulse in anticorruption work is often to crack down on
offenders without trying to tackle the more fundamental causes of corruption. Although effective
enforcement must be part of any credible strategy, enforcement alone is unlikely to constitute a
successful strategy. In many countries, judicial and law enforcement institutions remain part of
the problem, not the source of the solution. Prosecutions can be shelved. Judicial decisions can
be bought or indefinitely delayed. Police may be working for private security forces rather than
the public interest. In such cases, the enforcement approach could become an instrument for
repression or political victimization. Sequencing should be designed to begin to tackle the
incentives and institutions that favor corruption and to educate and raise awareness of the social
costs of corruption. The ultimate goal is to shift towards increased reliance on shared norms and
values, instead of inadequate enforcement measures.
Sustainability
The sustainability of an anticorruption strategy depends in any context on three key
dimensions. First, it requires a critical mass of mutually reinforcing reforms that ultimately
builds into a comprehensive program. Isolated islands of integrity can provide an entry point and
a valuable demonstration effect but may only survive a short time before being swamped by
corruption at other levels. In order to be mutually reinforcing, the strategy must also be balanced.
This suggests a mix of corruption prevention and enforcement measures combined with
substantial public involvement and education to strengthen the constituencies for reform.
Second, sustainability requires the eventual development of a broad coalition in support
of the strategy. Though gaining entry to anticorruption work might require an initially narrow
approach, any strategy that relies only on high-level leadership will be vulnerable to the many
uncertainties of the political process. The strategic commitment to gain entry must be broadened
to incorporate key state institutions and organizations within civil society. Small- and medium-


78
sized enterprises, professional societies, trade associations, and labor unions can all serve as
important partners in an anticorruption strategy. The development of a broad coalition will
reduce the vulnerability of anticorruption strategies to leadership changes and ensure that
politicians ignore the corruption issues at their peril.
Where civil society remains severely repressed or is emerging only slowly, a
combination of fear and/or lack of familiarity with civic involvement may inhibit popular
participation in an anticorruption strategy. The strategy will need to include a component that
can accelerate its emergence by canvassing client groups, promoting collective action, giving
voice to the poor, and setting up monitoring of government services at both national and sub-
national levels. External donors can play a role in funding and supporting mechanisms of voice
but should ensure that they do not dominate or pre-empt the development of authentic and
autonomous participation, sustainably based in the community.
Finally, sustainability requires the resources and expertise to see often complicated
reforms through to completion over the long haul as well as deliver the credible early results
noted above. This implies a mix of short-term measures and adequately funded medium-term
programs that can dig deeper into the underlying causes of corruption and build institutions that
can resist it. Well-intentioned reforms that are not realistically backed with sufficient resources
and expertise will backfire. Governments must assign budget resources as well as competent
administrators to these programs. Civil society can only do so much on its own. Business
associations and NGOs can help identify priorities and can monitor results, but they cannot
deploy the political will and resources of the state that ultimately are needed to reform the state
and create the framework for transparent and competitive markets.
1 Though it should also be acknowledged that foreign investors can also promote state capture in certain
environments especially where the other institutions of accountability and transparency are still poorly developed.
For a further discussion of this issues, see chapter 3.
2 See Mancur Olson's classic study, The Logic of Collective Action. (1965).
3 Surveys in the region repeatedly demonstrate this popular cynicism and lack of trust. See the many studies of
Richard Rose and Christian Haeffner.
4 "Stability Pact Anti-Corruption Initiative for South Eastern Europe-Compact," adopted at Working Table III,
Sarajevo, February 15-16, 2000. Full text available at http://www.stabilitypact.org.
5 See World Bank (2000).
6 This section draws on Philp (2000a and 2000b), Elster, Offe, and Preuss (1998), Holmes and Roszkowski (eds,
1997)), and World Bank Report, Making Transition Work for Everyone (2000).
7 The results presented in this box are from diagnostic surveys undertaken by the World Bank together with ACER
(Albania), GORBI (Georgia), Latvia Facts (Latvia), and Focus and Transparency International Slovakia (the Slovak
Republic). USAID cofinanced the surveys in Albania, Georgia, and the Slovak Republic. Results are provided in
Kaufmann and others (1998), Anderson and others (1999), Anderson (1998), and Anderson (2000).


Chapter 6: Conclusion
Designing, sequencing, and sustaining an anticorruption program pose tremendous
challenges but not impossible ones. Lessons of history and international experience suggest that
countries  have  succeeded  in
addressing  what   had   once
appeared to be an intractable       Fu6       Cnge int Extenfi
problem of endemic corruption.              Durn thE Last 5 Years
As described in Box 6.1, the
United States and the United
Kingdom   successfully reformed                                      Taiwan (China)
their  public  sectors  in  the                              Chile
nineteenth century. A number of                            Poland
countries in Latin America have                        jordan   Improvement
successfully  undertaken  initial              R
reforms, which could grow into               Pakistan
more comprehensive programs.                Indonesia
Evidence suggests that corruption
has declined in countries such as
Hong Kong and Singapore that     Ukraine
have undertaken comprehensive   -2       -1        0        1        2        3
and well-targeted reforms. These
success stories demonstrate thatun                  e  La      e
progress comes slowly, not as a result of noisy anticorruption campaigns, but because of
sustained commitment on the part of political leaders and pressure from society.


80
Box 6.1: Lessons from International Experience
In the nineteenth century, the United States and the United Kingdom successfully reformed their
systems of public administration and procurement. Three aspects of the process of institutional reform
account for its success. First, in both countries reform occurred under political systems that typically
produced two balanced parties alternating in power, both of which shared in the benefits of reform.
Second, reformist politicians in both countries successfully mobilized powerful business support for a
more efficient public service. In the United States, urban reform was given a push when graft levels
increased from 10 to 30 percent of the value of contracts. Businessmen were willing to tolerate a
certain level of corruption, but began to protest when the level of graft escalated. Finally, the reforms
became durable because they created a benevolent dynamic, in which partial changes created new
allies, and evolved over time into full-scale reform.
Reform of the public service in the United States started slowly at the federal level and focused on parts
of the bureaucracy in which new allies were produced by the process of change itself. Important
constituencies outside government benefited and helped to institutionalize reform. Inside government,
the first beneficiaries of civil service protection favored its preservation. Presidents about to leave
office extended civil service protection to their appointees. The proportion covered by the merit system
increased when overall government employment rose. Once the number of merit employees became
large, they emerged as a potent interest group in favor of maintaining the system. The move from 10 to
80 percent civil service coverage took almost 40 years.
Despite its ultimate success, reform in the United States did not proceed in a straight line. In some
cities, patronage-based and reformist administrations alternated in power. However, despite some
backsliding, patronage-based systems often maintained the reforms introduced by progressive
governments. Reforms were popular with the electorate and hard to reverse. Other countries have also
begun their reform process with partial reforms. The customs service in Mexico, the reinsurance system
in Argentina, and the city government of La Paz, have all recently experienced successful cleanups.
Reform in Mexico was based on simplifying procedures and improving pay and monitoring. A scandal
in Argentina led to changes in accounting practices. A reformist mayor in La Paz introduced a
composite package of projects that began with efforts to remove the worst offenders but went on to
include more fundamental changes.
Nevertheless, the durability of partial reforms is questionable. Reformers need to manage both the
political and bureaucratic fallout of reform and find ways to enlist or out-maneuver potential opponents.
In some cases, reform falters because of bad sequencing. Instead of generating a group of early winners
who support continuing reform, the program may create early beneficiaries who fear that they will lose
if reform continues. In the worst case they become a blocking coalition that prevents broad-based
change.
Countries with different models of government have also been successful with anticorruption and
governance reforms. The key elements in the already open economies of Hong Kong and Singapore
were comprehensive and meritocratic public sector reforms, backed by fair and effective enforcement
agencies. Both countries now have highly professional civil services, and Singapore's public service
has rates of pay relative to the private sector that are among the highest in the world. Starting in 1974,
Hong Kong took strong measures against corruption in the police force and the whole public service
and launched an anticorruption strategy based on prevention, education, and enforcement. Over a 26-
year period, they made dramatic reductions first in public sector corruption and, later on, in private
sector corruption. Each year the Independent Commission Against Corruption surveys the population
in order to study people's evolving perceptions and attitudes and refocus their preventive and
educational efforts accordingly.
There are lessons here for reformers in the transition countries. Economic liberalization should proceed
in tandem with efforts to establish transparency and accountability in state structures so that those who
benefit from the emerging private sector cannot block subsequent efforts to improve the efficiency and
fairness of the system. Equally critical to sustainable reforms are meritocratic, well-paid public
administrations, backed by credible judicial and enforcement agencies and reinforced by good lines of
communication with the population.
Based on Rose-Ackerman (1999, chapter 11) and sources cited within; and on advice from Bertrand de
Speville (former Commissioner of the Hong Kong Independent Commission Against Corruption).


81
The challenge ahead for transition countries is to make a durable commitment to tackle
corruption. The task will not be easy. The status quo often benefits powerful interests, making
the political economy of anticorruption initiatives complex and difficult. Corruption has become
pervasive in many transition countries. Capture has distorted the formal and informal rules of
the game to encode the advantages of particular groups into the very framework of the new
institutional environment. As the report has demonstrated, the roots of these problems reach
deep into historical legacies, economic structures, and transition paths. Thus, while there may
arise valuable windows of opportunity in specific countries, it remains important to manage
expectations and underscore the long-term nature of reform.
But as the report has shown, reform and progress are possible and the costs of doing
nothing are extremely high. Unbundling corruption and tailoring reform strategies to target the
specific profile of the problem in different countries provide important insights into the design of
effective anticorruption strategies. After ten years of transition, the building blocks of reform are
now better known, but the challenge remains to prioritize and sequence these reforms in a
manner that can build credible support for a sustainable process of change. By analyzing the
factors underlying the persistence of corruption in different contexts, this report provides an
approach for meeting this challenge. The World Bank, in partnership with domestic and
international actors, stands ready to work with the countries in the region in implementing
credible anticorruption strategies.


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Annex 1. Methodological Notes for Figures in the Text
The purpose of this Annex is to provide greater detail on the sources, statistical
significance, and methodological issues associated with the Figures presented in the text.
Chapter 1. The Level and Pattern of Corruption in Transition Countries
Figure 1.1: World-wide Perceptions of Corruption
Figure 1.1 presents a worldwide comparison of corruption based on an aggregate index
(Kaufmann, Kraay, and Zoido-Lobaton 1999a). The authors construct the aggregate
index for each country on the basis of the 12 most widely available corruption indices.
Error bars are provided to give a rough indication of the statistical margin of error
associated with each region's estimate. The estimation of these margins of error is based
on the margins of error of each country in the regional groupings. However, the
component indices themselves are estimates with (unknown) margins of errors,
suggesting that simple standard errors of regional averages may be understated. In an
attempt to mitigate this bias, the error bars in Figure 1.1 are calculated on the
conservative assumption that the errors are perfectly correlated, which tends to bias the
error estimates in the opposite direction.
Figure 1.2:  Administrative Corruption (bribes as a share of annual revenues)
This measure of administrative corruption is based on a survey question about the amount
of bribes paid by enterprises as a share of annual revenues. Since it is based on a survey
(the BEEPS), the margin of error of the estimates can be explicitly calculated, and error
bars (representing ± one standard deviation) are included in the figure. The measure of
administrative corruption in Figure 1.2 differs from the "bribe tax" presented in EBRD
(1999), although both were based on the BEEPS. The measure used in this report
includes the responses of all firms, whereas the measure presented in EBRD (1999)
presents the average bribes as a share of revenues, among firms that reported paying
bribes.
Figure 1.3:  State Capture Index
This measure of state capture was developed by Hellman, Jones, and Kaufmann (2000a).
The calculation of the margin of error for the state capture index is more complex than
that of administrative corruption, since it is the average of six subindices, each with their
own associated statistical error. To calculate the standard error of the overall index an
assumption must be made about the correlation between the measurement errors of the
components. The standard error of the aggregate index of state capture is calculated on
the conservative assumption that the errors of the components are perfectly correlated.
The estimated standard error of the index of state capture should therefore be interpreted
as an upper bound to the true standard error.


90
A further issue concerns the definition of state capture. The measure presented in the
report comprises six components-"sale" of (i) parliamentary votes and (ii) presidential
decrees to private interests; the sale of (iii) civil and (iv) criminal court decisions to
private interests; (v) corrupt mishandling of central bank funds; and (vi) illegal
contributions by private actors to political parties. Table A.1, below, presents alternative
estimates of state capture, excluding court decisions and mishandling of central bank
funds, whose link to the concept of state capture is relatively more tenuous than the
purchase of legislation and politics. (See endnote 16 to Chapter 1.) The alternative
measures of state capture are very similar to the one use used in the report. Table A.2
provides the correlation coefficients between the alternative measures of state capture. In
all cases, the correlation exceeds 0.97. Finally, it should be noted that since the standard
errors of the components of the index of state capture were assumed to be perfectly
correlated, a very conservative assumption, an index with fewer components would not
be less precise than the index used in this report.
Table A.1 The Effect of Excluding Central Bank and Courts
from the Measurement of State Capture
Country      State Capture   State Capture    State Capture      State Capture
including all  excluding central  excluding courts  excluding both central
components         bank                           bank and courts
Albania          16               13               17                   15
Armenia           7                8                7                   8
Azerbaijan       41               41              40                   38
Bulgaria         28               31              29                   33
Croatia          27               26              27                   26
Czech Rep.       11               12               11                  12
Estonia          10               12               11                  13
Georgia          24               27              24                   27
Hungary           7                8               7                    8
Kazakhstan       12               12              13                   13
Kyrgyz Rep.      29               30               32                  35
Latvia           30               33              26                   28
Lithuania        12               11               12                  12
Moldova          37               39               38                  42
Poland           12               10               12                  10
Romania          21               24              21                   25
Russia           32               35               31                  35
Slovak Rep.      24               22              26                   26
Slovenia          7                7               7                    8
Ukraine          32               37               31                  37


91
Table A.2 Correlation Coefficient for
Alternative Measures of Capture
State Capture  State Capture  State Capture  State Capture
including all  excluding     excluding   excluding both
components    central bank    courts      central bank
and courts
State Capture including all  1.000
components
State Capture excluding     0.986          1.000
central bank
State Capture excluding     0.992         0.971         1.000
courts
State Capture excluding     0.975         0.983         0.983          1.000
both central bank and
courts
Figure 1.4:   Typology of Corruption
Based on Figures 1.2 and 1.3 a typology of corruption in the transition economies is
developed, generating the scatter plot in Figure 1.4. For the purposes of analysis in
subsequent chapters, the countries in Figure 1.4 have been divided into four groups on the
basis of thresholds of administrative corruption and state capture. This produces a two-
by-two matrix that groups countries on the basis of similarities in both the level and
pattern of corruption.
Figure 1.4 has been reproduced in Figure A.1, below, with dotted lines added to
distinguish between the four groups of countries. The composition of the groups is based
on the determination of these dividing lines, which is done here for analytical purposes
only. As several countries lay close to the thresholds, their inclusion into either group is
subject to a greater margin of error. However, the availability of estimates of standard
errors makes it possible to estimate the probability that a country has been misclassified,
even within the empirical typology presented in the Report. (As stressed in the text, the
typology is "not intended to define absolute and unambiguous divisions among countries.
Rather it is presented as a heuristic device to highlight analytically and empirically the
differences in patterns of corruption across countries.")


92
Figure A.1. Typology of Corruption, with Risk of Misclassification
Medium                        High
45                      - -
40                                          A ze  a  an
Moldova
35         - - -     - -  - - -H                       igh
Latvia          Russia       Ukraine Kyrgyzstan
30  a---a----_aa
Croatia
S 25
d         Rorarla
S20--____
5   -- -    --  --
Poland  C         Kazakhstan               Medium
10     -epublic                    -     Armenia
5   Sloveniar_I_
0       1        2       3       4       5        6
Admlnistrative corruption
Source: BEEPS
Figure A. 1 illustrates the typology with point estimates (depicted by the symbol m) as
well as estimates of 90 percent limit values in the direction of the other quadrants. For
the medium/medium quadrant, for example: one could be 90 percent certain that the true
value of state capture lies below the point +, and 90 percent certain that the true value of
administrative corruption lies to the left of the point A. This is equivalent to carrying out
a one-tailed test of the difference between the point estimate for each country and the
(arbitrary) dividing line. For those countries for which + or A lie in a different quadrant
from u, there is less than 90 percent chance that the country is correctly classified in that
particular dimension. The method of calculating the confidence intervals assumes, for
the sake of simplicity, that the position of the dividing lines is independent of the
uncertainty in the point estimates.
The one-tailed tests described above were also used to estimate the probability of
misclassification, and the estimates are presented in Table A.3, below. On the dimension
of state capture, only three countries - Albania, Slovakia and Romania - demonstrate a
reasonable risk of misclassification. The measure of administrative corruption has a
more continuous distribution with more countries having a non-negligible risk of
misclassification, including the Czech Republic, Kazakhstan, Lithuania, Romania,
Slovakia and Russia.


93
Table A.3 - One-tailed tests for misclassification
Probability of misclassification with a one-tailed test
Country            Administrative corruption            State capture
Albania                      0.00                           0.23
Armenia                      0.00                           0.00
Azerbaijan                   0.00                           0.00
Bulgaria                     0.09                           0.03
Croatia                      0.00                           0.03
Czech Rep.                   0.38                           0.01
Estonia                      0.00                           0.00
Georgia                      0.00                           0.10
Hungary                      0.00                           0.00
Kazakhstan                   0.15                           0.07
Kyrgyz Rep.                  0.00                           0.06
Latvia                       0.00                           0.00
Lithuania                    0.35                           0.03
Moldova                      0.01                           0.00
Poland                       0.00                           0.00
Romania                      0.10                           0.28
Russia                       0.26                           0.00
Slovak Rep.                  0.33                           0.12
Slovenia                     0.00                           0.00
Ukraine                      0.00                           0.00
Countries with a greater than 10% chance o misclassification are highlighted in bold
The discussion above centers on statistical margin of error. A second potential source of
error could arise if the quality of the survey implementation varied greatly across
countries, or if there are systematic differences in respondents' perceptions of the severity
of otherwise identical problems in different countries. However, the BEEPS was carried
out by the same international company in all countries except two (Latvia and Albania) to
ensure consistency, so variation in the quality of survey implementation is not a concern.
Furthermore Hellman, Jones, Kaufmann, and Schankerman (2000) test for the presence
of systematic cross-country biases in the BEEPS (whatever their source) using a
methodology that compares estimates derived from the BEEPS with measures of the
same concept from other sources. They find no evidence of such bias.
Figure A.2 State Capture and Captor Firms
45  -
5 40 +Azerbaijan
S40
*Moldova
35
+Russia * Ukraine
30                +Kyrgyz Rep.  *i Latvi
 C r o a tia   n
25                 * Georgia  vak Rep.
2+ Romania
0
e- 15 Albania
a            +Hungary *Armenia  Slovenia
0   5
0
0.00       0.05       0.10      0.15       0.20       0.25      0.30
Source: BEEPS       Proportion of firms actively engaged in capturing the state


94
The measure of state capture used throughout this report represents the proportion of
firms that report being affected by state capture, whether or not the firms actively engage
in state capture. The reason is that the degree to which a state is captured is not
necessarily related to the number of firms that engage in such forms of influence, but the
extent to which the formation of policy is distorted by private interests.
The levels of state capture and the proportion of firms that engage in capture are
positively related. Figure A.2 presents a scatterplot demonstrating the high correlation
(correlation coefficient = 0.69) between the index of the perception of state capture and
active engagement in such activity. Even after removing Azerbaijan, which appears to be
an outlier, the correlation remains high: the correlation coefficient becomes 0.51 and the
slope coefficient is significant at the 5 percent level. These correlations give some
additional confidence in the state capture index used throughout this report.
Chapter 2. The Economic and Social Consequences of Corruption in Transition
Economies
All of the figures in Chapter 2 show the average of some variable over the countries in
each of the four typologies, as depicted in Figure 1.4. The theme of Chapter 2, the
economic and social consequences of corruption, calls for analysis whereby corruption is
the cause of certain social ills.
Empirical analyses of causation are inherently difficult, and the timing and availability of
data exacerbate the difficulty. First, as discussed in the text, there may be multiple
feedback loops between corruption as a cause and a consequence of various economic
and social problems, and both are further influenced by yet other factors. Given a static
data set with only 20 observations, there are clear limits to the degree of sophistication
one can expect from any model. Second, the BEEPS was undertaken in the summer of
1999, in many cases after the measurement of what we would normally think of as the
dependent variables. Given this timing, establishing causation would be difficult indeed.
Similarly, controlling for factors that may be influencing levels of all three variables of
interest-administrative corruption, state capture, and whichever "cost" is being
investigated--faces similar hurdles of complex interactions and a small number of cross-
country observations.
The charts in Chapter 2, therefore, do not attempt to control for other factors or to
establish empirically a direction of causation. Rather, they depict the simple association
between the variable of interest and levels of administrative corruption and state capture.
Their purpose is not to provide empirical evidence of causation, but to show that the data
are consistent with the idea, reasoned in the text, that corruption is deleterious for society,
even if the figures themselves only depict simple correlations between variables. While
the figures in Chapter 2 make no attempt to control for external factors or to establish
causation, the broader literature on governance and corruption, availing itself of a greater
number of countries and governance indicators, includes studies that support the ideas
argued in the text-that corruption does indeed pose quantitatively large economic and
social consequences on society.


95
Table A.4 presents simple evidence that the figures in Chapter 2 represent relationships
that are statistically significant, even if not so in a ceterisparibus sense.
Table A.4 Statistical Relationships between Chapter 2 "Consequences" and State Capture and
Administrative Corruption
OLS Regressions
Simple t-test between      t-statistics of coefficients
Figure and        High-High and the         (p-value in parentheses)
Variable of    Medium-Medium groups   Administrative  State      F      N  R-sq
Interest             of countries       Corruption   Capture  (p-value)
2.1 Output              5.33               2.02*      2.84**    0.01    20 0.55
decline              (0.00)            (0.06)      (0.02)
2.2 Poverty             2.81               3.88***     0.04     0.00    19 0.54
(0.01)            (0.00)      (0.97)
2.3 Gini                3.03               2.29**      0.81     0.06    17 0.34
coefficient          (0.01)            (0.04)      (0.43)
2.4 Unofficial          3.17               2.04*       1.35     0.01    15 0.56
economy              (0.01)            (0.07)      (0.20)
2.5 Macro               4.24               1.81*       1.28     0.03    20 0.27
governance           (0.00)            (0.09)      (0.22)
2.6 Organized           4.57               1.93*      1.78*     0.01    20 0.42
crime                (0.00)            (0.02)      (0.02)
One-tailed tests, assuming equal variances.  Significance levels: * = 10 percent level; ** = 5
(p-values in parentheses)             percent level; *** = 1 percent level.
Figure 2.1:   Corruption and Output Decline
Output decline is the percentage decline in GDP between 1989 and 1998. All countries in
Figure 1.4 are included in Figure 2.1. The data are based on Table 3.1.1 of EBRD
Transition Report 1999, p. 73. See Table A.4 for an indication of simple statistical
significance.
Hellman, Jones, and Kaufmann (2000a) use the BEEPS data to examine (with controlled
regressions) the impact of corruption on investment at the firm  level.  Additional
empirical studies on the relationship between corruption and growth and investment
include: Mauro (1995, 1997), Kaufmann (1997), World Bank (1997), Tanzi (1998),
Kaufmann and Wei (1999), Campos, Lien, and Pradhan (1999), and Wei (1999a, 1999b,
and 2000).
Figure 2.2:   Corruption and Poverty
Poverty is represented by the percentage of the population living on less than $2.15 per
day. (See Table A.4 for an indication of simple statistical significance.) All countries in
Figure 1.4 are included in Figure 2.2, with the exception of the Slovak Republic. The
data are drawn from the World Bank report, also prepared for the 2000 Annual Meetings
in Prague, Making the Transition Work for Everyone: Poverty and Inequality in Europe
and Central Asia, Chapter 1, Table 1. This "poverty head-count" is based on household
surveys undertaken in 1996-1999 (surveys from 1998 or 1999 were used for most


96
countries; Bulgaria's headcount is based on a 1995 survey). Income levels of have been
PPP adjusted.
Additional empirical studies on the relationship between corruption and poverty include
Knack and Anderson (1999), and Gupta, Davoodi, and Alonso-Terme (1998).
Kaufmann, Kraay, and Zoido-Lobaton (1999b) show the relationship between poor
governance and nonpecuniary measures of well-being such as infant mortality. See also,
World Bank (2000) Making the Transition Work for Everyone: Poverty and Inequality in
Europe and Central Asia.
Figure 2.3:  Corruption and Income Inequality
Income inequality is represented by the Gini coefficient and is drawn from the World
Bank report, also prepared for the 2000 Annual Meetings in Prague, Making the
Transition Work for Everyone: Poverty and Inequality in Europe and Central Asia,
Chapter 4, Table 1. The Gini coefficients are World Bank estimates based on household
surveys from 1996-1999. All countries in Figure 1.4 are included in Figure 2.4, except
Azerbaijan, the Slovak Republic, and Ukraine. See Table A.4 for an indication of simple
statistical significance.
The relationship between corruption and inequality has also been examined in Gupta,
Davoodi, and Alonso-Terme (1998), and Knack and Anderson (1999). See also, World
Bank (2000) Making the Transition Work for Everyone: Poverty and Inequality in
Europe and Central Asia.
Figure 2.4:  The Unofficial Economy
Estimates of the unofficial economy, based on changes in electric power consumption
and officially measured GDP, are drawn from Johnson, Kaufmann. and Shleifer (1997).
All countries in Figure 1.4 are included in Figure 2.5, except Albania, Armenia, Croatia,
the Kyrgyz Republic, and Slovenia. See Table A.4 for an indication of simple statistical
significance.
Studies of the unofficial economy and its link to corruption include Johnson, Kaufmann,
and Shleifer (1997), Johnson, Kaufmann, and Zoido-Lobaton (1998), Johnson,
Kaufmann, McMillan, and Woodruff (2000), and Friedman, Johnson, Kaufmann, and
Zoido-Lobaton (2000). See also Kaufmann, Pradhan, and Ryterman (1998) for an
illustration of the degree to which corruption leads to a loss in tax revenues.
Figure 2.5:  Quality of Macroeconomic Governance
Macroeconomic governance is an index measuring the extent to which policy instability,
exchange rate instability, and inflation are obstacles for business. The data are drawn
from the BEEPS. An almost identical index is presented in Table 6.1 of EBRD
Transition Report 1999, p. 116. All countries in Figure 1.4 are included in Figure 2.6.
See Table A.4 for an indication of simple statistical significance.
The relationship between corruption and budget distortions has been examined in Mauro
(1998), and the effect on international trade in Anderson and Marcouiller (1999).


97
Figure 2.6:  Organized Crime as a Problem Doing Business
Organized crime is the percentage of firms that reported that organized crime is a
problem doing business in the BEEPS. All countries in Figure 1.4 are included in Figure
2.7. See Table A.4 for an indication of simple statistical significance.
Chapter 3. The Origins of Corruption in Transition Countries
The challenges of analyzing the costs of corruption-paucity of cross-country
observations and mis-timed data-are not so formidable for analyses of the origins of
corruption. (i) Influences on firm-level decisions regarding corruption can be unearthed
using firm-level analysis, for which the BEEPS provides thousands of observations. (ii)
Since the object of investigation is the set of causes of state capture and administrative
corruption, the fact that both are measured in 1999 is entirely consistent with such a
model. For these reasons, the analysis of the origins of corruption in transition countries
was able to benefit from a multivariate framework. While still stopping short of
addressing all possible endogeneity issues, this approach does provide a measure of rigor
beyond what was possible in Chapter 2.
Underpinning this analysis in Chapter 3 are a series of firm-level regressions, in which
state capture and administrative corruption are explained by firm, industry, and country
characteristics. These characteristics include: (i) the size, ownership form, and age of
the firm; (ii) dummy variables describing the industry of the firm and its membership in a
business association; and (iii) variables measuring institutional legacies of a country, such
as the natural log of the number of years it was a state in the last century, a dummy
variable indicating whether it was a member of the CIS, a dummy variable indicating
whether it had been part of the Habsburg Monarchy, a dummy variable indicating
whether it was centrally planned (as opposed to labor managed or market socialist), an
index of political liberalization at the onset of transition, an index of economic
liberalization at the onset of transition, a dummy variable indicating whether it was
resource rich, and more. Generally, those variables described by the figures in the text
were those that were significant and robust to many different specifications.
Surprisingly, a dummy variable measuring whether a country is in the CIS was useful in
explaining administrative corruption, but not state capture.


98
Table A.5 Statistical Relationships between Chapter 3 "Origins" and State Capture and
Administrative Corruption
OLS Regressions
Simple t-test            t-statistics of coefficients of
between High-                variable of interest
High and the              (p-value in parentheses)
Figure and     Medium-          Administrative         State Capture      N   R-sq
Variable of    Medium groups    Corruption regressed on  regressed on
Interest       of countries     variable of interest   variable of interest
3.1 Statehood     1.51*              -1.89*                               20 0.17
(log)          (0.08)            (0.07)
-1.30        20 0.09
(0.21)
3.2 Habsburg       4.83***           -3.06***                             20 0.34
legacy         (0.00)            (0.01)
-1.85*       20 0.16
(0.08)
3.3 Democracy      5.51***           -4.06***                             20 0.48
(0.00)             (0.00)
-2.27**       20 0.22
(0.04)
3.4 Resource       0.87              1.12                                 20 0.07
endowments     (0.20)            (0.28)
1.18        20 0.07
(0.25)
3.5 Change in      3.23***           -1.13                                20 0.07
leadership    (0.01)             (0.27)
-2.81**       20 0.30
(0.02)
One-tailed tests, assuming equal  Significance levels: * = 10 percent level; ** = 5 percent level;
variances. (p-values in parentheses)  *** = 1 percent level.
Figure 3.1:   Statehood and Corruption
The measure of experience with sovereignty is the number of years during the previous
century that the country was a sovereign state. Of course, during this period, national
borders for countries shifted dramatically. For the purposes of this analysis, a country
continues to be classified as a sovereign nation following a significant change in its
borders as long as the central government continues to be administered from its capital
city. Thus, Russia and the Czech Republic are classified as sovereign nations during their
Soviet and Czechoslovak periods, respectively, while the other states in the former Soviet
Union and the Slovak Republic are not. All countries in Figure 1.4 are included in Figure
3.1. See Table A.5 for an indication of simple statistical significance.
Figure 3.2:   Habsburg Legacy and Corruption
The countries that were formerly part of the Habsburg monarchy are Croatia, the Czech
Republic, Hungary, Poland, the Slovak Republic, and Slovenia. All countries in Figure
1.4 are included in Figure 3.2. See Table A.5 for an indication of simple statistical
significance.


99
Figure 3.3:  Democracy and Corruption
The data on democracy comes from Adelman and Vujovic (1997). The measure of
democracy is an average of measures of the political independence of the country, the
existence of a multiparty system, presence of political opposition, degree of political
decentralization, role of elections in the political system, freedom of speech, and freedom
to organize. All countries in Figure 1.4 are included in Figure 3.3. See Table A.5 for an
indication of simple statistical significance.
Figure 3.4:  Resource Endowments and Corruption
The countries that are resource-rich, for the purposes of Figure 3.4, are Azerbaijan,
Romania, Russia, and Kazakhstan. All countries in Figure 1.4 are included in Figure 3.4.
Although Table A.5 suggests that resource endowments are only weakly related to
administrative corruption and state capture, in a multivariate framework, resource
endowments are consistently significant. See Table A.5 for an indication of simple
statistical significance.
Figure 3.5:  Change in Leadership and Corruption
The countries with early changes in leadership are Armenia, Czech Republic, Estonia,
Georgia, Hungary, Kyrgyz Republic, Latvia, Lithuania, Poland, the Slovak Republic, and
Slovenia. All countries in Figure 1.4 are included in Figure 3.5. See Table A.5 for an
indication of simple statistical significance.
Figure 3.6:  Economic and Political Reform and State Capture
The degree of economic reforms was measure by the EBRD Transition Indicators, 1999.
The level of civil liberties is the three year average of the Freedom House Civil Liberties
Index, which is based on assessments of freedom of expression and belief, association
and organizational rights, rule of law and human rights, personal autonomy and economic
rights. Figure 3.6 plots regression fits based on a regression of state capture (SC) on civil
liberties (CL) and economic reforms (ER). A quadratic term is included for civil liberties
to allow for curvature in the relationship. Basic regression statistics are presented below.
(A constant was included but is not reported; t-statistics are in parentheses.)  The
regression was presented in Hellman, Jones, and Kaufmann (2000a), which also contains
a broader discussion of the relationship between political and economic liberalization and
state capture.
SC = a + 0.359  CL - 0.056   CL   - 0.143  ER              R-sq = 0.513
(1.93)*      (1.97)*       (1.87)*
Figure 3.7:  Foreign Direct Investment and Corruption
Data in Figure 3.7 are based on the BEEPS and draw on Hellman, Jones, and Kaufmann
(2000b). Firms were grouped into three categories: (i) those with no foreign direct
investment (FDI), (ii) those that have FDI and whose headquarters was domestically
located, and (iii) those that have FDI and whose headquarters are located in another
country. Pairwise t-tests of the levels of administrative corruption and state capture for
these sets of countries are presented Table A.6, below.


100
Table A.6 Significance of FDI (and Location of Headquarters) for Levels of
Administrative Corruption and State Capture
Pairwise t-tests for Differences in Means
Variable 1              Variable 2           Administrative Corruption  State Capture
Firms with no FDI       Firms with FDI and            0.16                2.58***
Domestic HQ                  (0.43)                (0.01)
Firms with no FDI       Firms with FDI and           2.28**                1.60*
Foreign HQ                   (0.02)                (0.06)
Firms with FDI and      Firms with FDI and           2.47***              2.44***
Domestic HQ             Foreign HQ                    (0.01)               (0.01)
One-tailed tests, assuming equal variances.  Significance levels: * = 10 percent level; ** = 5
(p-values in parentheses)                   percent level; *** = 1 percent level.
Figure 3.8:   Foreign Direct Investment in High-Corruption Countries
Data in Figure 3.8 are based on the BEEPS and draw on Hellman, Jones, and Kaufmann
(2000b). Firms are divided into three groups as described above for Figure 3.7. Figure
3.8 then shows the average percent of firms that engage in capture and the percentage of
firm revenue paid in bribes, across firms in high and medium capture countries,
respectively. For both of the charts in Figure 3.8, active capture and administrative
corruption are most prevalent among firms with FDI and domestic headquarters, but only
in high capture countries.
Figure 3.9: Variation Within and Between Sub-regions
The data for Figure 3.9 are drawn from the BEEPS. Figure 3.9 simply presents the levels
of administrative corruption and state capture for each country, according to the indicated
sub-regions.
Chapter 4. A Multi-pronged Strategy for Combating Corruption
Chapter 4 has only two charts that suggest statistical relationships. Simple statistics on
the significance of the relationships are presented in Table A.6. As discussed earlier,
these relationships are not ceteris paribus but are merely presented as illustrations of a
statistical association.
Table A.6 Statistical Relationships of Chapter 4 Charts
OLS Regressions
Simple t-test between       t-statistics of coefficients
Figure and        High-High and the          (p-value in parentheses)
Variable of     Medium-Medium groups   Administrative   State      F      N   R-sq
Interest             of countries        Corruption    Capture  (p-value)
4.2 Media                7.50               3.02***      1.52     0.01    20 0.53
repression            (0.00)            (0.01)       (0.15)
4.3 Business             3.00               3.21***      0.78     0.00    20 0.49
Assoc.               (0.01)             (0.00)       (0.44)
One-tailed tests, assuming equal variances.  Significance levels: * = 10 percent level; ** = 5
(p-values in parentheses)              percent level; *** = 1 percent level.


101
Figure 4.2:  Media Repression
Media repression is based on the Press Freedom Survey as presented in Sussman (1999).
It is an index of many dimensions of media repression. All countries in Figure 1.4 are
included in Figure 4.2. See Table A.6 for an indication of simple statistical significance.
Figure 4.3:  Business Associations and Corruption
All data are based on the BEEPS. All countries in Figure 1.4 are included in Figure 4.3.
See Table A.6 for an indication of simple statistical significance.
Chapter 5. Designing Effective Anticorruption Strategies
Figure 5.3:  The chart is from Anderson (2000). It is based on a survey of 400
enterprise managers in the Slovak Republic carried out in 1999 by the Focus Agency for
the World Bank and USAID.
Figure 5.4:  These charts are based on diagnostic surveys undertaken in Albania (see
Kaufmann, Prasha, Preci, Ryterman, and Zoido-Lobaton (1998)), Georgia (see Anderson,
Azfar, Kaufmann, Lee, and Mukherjee (1998)), Latvia (see Anderson (1998)), and the
Slovak Republic (see Anderson (2000)). Several of the surveys were supported by
USAID. The Albania public officials survey was undertaken by ACER in 1998, and had
a sample size of 97. The Georgia enterprise survey was undertaken by GORBI in 1998
and had a sample size of 350. The Latvia household survey was undertaken by Latvia
Facts in 1998 and had a sample size of 1,100. The Slovak Republic public officials
survey was undertaken by Focus is 1999 and had a sample size of 350.
Chapter 6. Conclusion
Figure 6.1:  Change in the Extent of Bribery During the Last 5 Years
The data used to create Figure 6.1 are from the Global Competitiveness Survey, World
Economic Forum, available at http://www.weforum.org. The chart was kindly provided
by Daniel Kaufmann.




THE                                            years after the fall of the Berlin Wall,
T H  W 0R L  B AN Kthe countries in Central and Eastern Europe
118 H ftaSum. N.".
J~sI H trce.  ~and the Commonwealth of Independent
H%ashingion, D..2045 L3 U
~~a%ingIn. 1* .OI3~L~'States still face major challenges: although
Telephone: 202-477-123+                 much has been achieved in the transition to
Fac,imile: 202-477-o31                  market-based democracies, much remains to
Tclex: NIC t-ISb15 WORLDB%k           be done. The World Bank has been an active
4partner in helping countries design and im-
plement their reforms.
Inernev "ww%.orldbanL org
E-mail: books-4"otdSant oag The region has witnessed many successes, as
well as setbacks, in the transition process. This
series of publications is part of the Bank's con-
tribution to the debate about the unfinished
agenda and possible approaches to future chal-
lenges. The 14 titles in the series cover the
issues of resurgent poverty and inequality the
importance of sound corporate citizenship,
strategies for better education systems, social
and environmental protection, institution
building, investments, and livable cities.
The series was prepared to facilitate the discus-
sions during the thematic seminars at the 2000
Annual Meetings of the World Bank and the
International Monetary Fund in Prague, and
the broad-based dialogue to follow
0-8213-4802-7