The Nexus Of Corruption And Higher Income Part IV

For all those who are interested in playing around with the dataset I used for the first three parts of this series, I’ve uploaded it to Google Docs. Just follow this link.

In this instalment, I’m going to narrow down the investigation and concentrate on one particular question that seems to be cropping up more frequently. And that’s the idea that if only Malaysia had less corruption, we’d be on par with countries like South Korea and Taiwan.

I’ll get to the quantitative part in a moment, but in normative terms, this idea has one big flaw – it presumes that Taiwan and Korea as societies are more corruption-free than Malaysia is or was. Anybody reading the history of politics in Korea and Taiwan would immediately realise that we’re not all that much different.

For instance, here’s an excerpt from a University of London paper on corruption in Taiwan (excerpt):

Democratisation, Liberalisation, and Political Corruption in Taiwan

…When the KMT regime arrived in Taiwan it needed grassroots support for local elections, and therefore it established a patron–client alliance with the local factions that remained intact and unchallenged until democratization...Under this form of institutionalized corruption the KMT was prepared to tolerate corruption at the local level, while the central government and bureaucracy maintained a reputation of being relatively clean...in return for affiliating with the KMT local factions were rewarded with local economic monopolies, special loans and credits from state owned commercial banks, and local government public contracts. In addition, the central government turned a blind eye to factional links with organized crime and involvement in land speculation and illegal businesses, such as gambling houses, brothels and dance halls. A major component of local-level corruption has been the involvement of gangsters in politics, a phenomenon known as “black gold.”...

...During the KMT’s five decades in power it took advantage of its dominant position to accumulate a vast real estate and business empire, and set up monopolies for its own companies, making it the fifth biggest business syndicate in Taiwan and richest political party in the world. Through a number of holding companies, the KMT invested in over 100 companies, including cement, construction, insurance, finance and media enterprises. The profits from these companies have enabled the KMT to outspend its rivals in election campaigns and employ thousands of party cadres in its central, provincial, city and county headquarters and community service centres throughout the island. The existence of the KMT’s alliance with local factions and its party assets reflect the weakness of using legal standards to define political corruption in an authoritarian context, as the KMT was able to design the legal framework that legitimized ruling party corruption.

Sound familiar? Here's another paper describing corruption in Korea (excerpt):

Looters, Rent-Scrapers, and Dividend-Collectors: Corruption and Growth in Zaire, South Korea, and the Philippines

Although given a middling rank for corruption (a low of 4.24 in 1982 and a high of 6.50 in 1992), South Korea has in reality experienced widespread, high-level corruption ever since it became independent in 1945...

... Although his administration is often characterized as notoriously corrupt, South Korea's first president Syngman Rhee does not seem to have abused his power for personal gain but rather relied on a system of "rent-farming" to maintain his grip on power...Rhee required rent-seekers and profiteers to finance the ruling Liberal Party. Rhee also stole from the treasury. But unlike Mobutu, he did it indirectly and primarily for political purposes. During the 1956 presidential election, for example, Rhee had the state-controlled banks issue 17 million won in loans to his business allies, who immediately kicked back the entire amount as "contributions" to the Liberal Party...

…After seizing power in a 1961 coup, Park Chung-hee cracked down on rent- scraping and profiteering, expropriating the wealth of some of Rhee's cronies, jailing corrupt officials and politicians, and purging corrupt military offlcers. Park did not, however, stop extorting funds from the business sector. Quite the contrary, he actually increased the squeeze. He abandoned Rhee's system of using import-substitution industrialization to support rent-farming and shifted over to a strategy based on export-oriented industrialization (EOI) and heavy industrial development. To finance concurrent export-oriented industrialization and heavy industrialization, Park renationalized the banks, pushed interest rates down below market levels, increased total capital stocks by borrowing heavily on international credit markets, and centralized control over the allocation of capital. Having gained control over the price and allocation of capital, Park then channeled cheap capital to selected sectors and firms based on their potential to contribute to development-and their willingness to contribute to Park's Democratic Republican Party (DRP)...

... After Park's assassination, Chun Doo-hwan and Roh Tae-woo continued the practice of forcing firms, including the major conglomerates known as the chaebol, to fund the ruling party... through a combination of commissions, kickbacks, and forced donations. Although uncertainty about how much money Park extorted makes exact comparisons difficult, it appears that Chun compelled the chaebol to contribute more than they had under Park. According to charges brought against him in 1995, Chun amassed a political slush fund totaling US $890 million and accepted bribes totaling $273.35 million during his seven years in power...Chun's successor Roh Tae-woo followed the same path, accepting $654 million in "donations" during his five years in office, $396 million of which prosecutors charged was in the form of outright bribes, the rest being either "goodwill" money or under-the-table political contributions.

The Chun administration also witnessed the proliferation of corruption. Whereas Park kept a tight grip on "big graft" and vigorously prosecuted corruption among low-ranking officials, Chun and Roh allowed their lieutenants to rake off a percentage of the bribes and kickbacks they squeezed out of the chaebol. Even if South Korea never degenerated into a "racketeering state" as Martin Hart- Landsberg claims it did, it remains true that many senior officials in the Chun and Roh administrations-including a dozen ministers, a dozen senior military officers, half a dozen presidential advisers, the chief justice of the Supreme Court, the speaker of the National Assembly, the chief of the National Police Administration, the mayor of Seoul, and a host of other officials-were subsequently charged with bribery, corruption, and illegal land speculation...

Anybody need reminding that the Chairman of Samsung was forced to resign for operating a bribery slush fund in 2008, and was subsequently pardoned despite being convicted? And in Taiwan two years ago, three judges and a public prosecutor were caught for being bribed into allowing a corrupt politician off the hook. Reading through this stuff, Malaysian corruption seems like small potatoes.

But let’s take a look at the quantitative evidence. I’m including here not just South Korea and Taiwan, but also Hong Kong, Singapore, Thailand and Indonesia. The following chart shows PPP adjusted real GDP per capita in 2005 prices (chain series) from the Penn World Tables in international USD from 1950 to 2009 (click on any of the following charts for a larger version):

As you can see, both Hong Kong and Singapore have been way ahead of Malaysia, even going back to the 1960s. Taiwan and Korea had similar income levels in the 1960s, but gradually pulled away from the 1980s onwards.

Here’s another look at the same dataset:

This one shows the log difference between the Malaysian real GDP level and the rest – essentially showing Malaysian income levels as a ratio to the rest. For instance, Thailand’s per capita income level has been more or less fluctuating 50% below the Malaysian level, while Hong Kong and Singapore are both at least 100% or double Malaysia’s per capita income.

You’ll note however that both Korea and Taiwan have been increasing over time against Malaysia. But the degree to which that has happened is quite different, so here’s a closer look:

You could make a fair argument that Taiwan’s development lead over Malaysia has been continuously increasing; if you try regressing the difference, you’d probably get a statistically significant coefficient estimate.

Korea though is different (and I’d argue that Taiwan’s the same). Up to the 1980s, the difference in income level difference between Korea and Malaysia fluctuated between 35% and 10% (I’ll show why in  bit). It was only in the early 1980s that Korea pulled away, and they added a smidgen more during the 1997-98 financial crisis. The latter hit both countries, but evidently Malaysia was much worse hit than Korea was. But since then – the last decade or so – Korea’s lead has stagnated.

You could use the same interpretative approach for Taiwan. You can see two (or three if you include 1997-98) growth spurts relative to Malaysia – the early 1960s and the mid-1980s. Taiwan began industrialising much earlier than Malaysia did – we only began in the early 1980s. That could explain the leap from near parity in 1955 to Taiwan having 50% higher income by 1970. But again, in the last decade, the relative income levels have not changed much.

(Ironically, Malaysia started closing the gap in the early 1990s, just about when both Taiwan and Korea were undergoing democratic revolutions and clamping down on corruption – go figure).

Here’s a look at different measurement, the ratio of Malaysian, Korean and Taiwanese incomes relative to the US income level (again log differences):

The picture here is even clearer. In the case of both countries, their gains over Malaysia could be divided into two periods; the first in the 1960s, and the second in the first half of the 1980s.

The pulling away of both Korea and Taiwan in the 1980s involves three interrelated sources affecting the Malaysian economy – a commodities price bust, the Plaza Accord, and the deep recession of 1985-86. To deal with the former first (USD):

Palm oil wasn’t as big back then as it is today, but both rubber and tin were major export commodities for Malaysia up to that point. Between 1980 and 1985, you had a massive crash in the price of tin, which fell from a peak of over USD17,000 to just over USD5,000 per metric tonne by 1986 – a third of the drop was in the first few months of 1986 alone. The drop in rubber prices wasn’t quite as sharp, but it still represents a 50% drop in those same years.

Which brings us to the second point, which is the Plaza Accord agreement signed in September 1985, wherein the major advanced economies intervened in the currency markets to devalue the USD against the JPY and DMK. This had the side effect of hammering the value of the MYR which lost 20% of its value against the USD (and even more against other major currencies GBP) between 1984 and 1986, and exacerbated the sharp drop in export receipts:

That in turn contributed to source number 3 – the deep, deep recession of 1985-1986:

What differentiated the recession of 1985-86 against the bigger drop in GDP in 1998 and the similar drop in 2009 was its length – the economy contracted for two straight years, the longest recession in Malaysian history. By contrast, the 2008-2009 recession lasted barely three quarters. To make matters worse, the depreciation of the currency also reduced GDP levels in USD terms – a double whammy.

Korea and Taiwan’s biggest income gains relative to Malaysia took place in those years – Korea went from around 20% greater income than Malaysia in 1980 to over 60% by the end of 1986. Taiwan’s gains were almost as great.

Also consider that anti-corruption measures and wider democracy only took hold in Taiwan and Korea in the late-1980s and early-1990s, after the gains against Malaysia occurred; while stronger more effective campaigns against corruption occurred in the past decade, precisely when their lead stopped growing. Given that, it’s much harder to argue the case that reducing corruption alone accounts for the difference in income levels between the three countries.

Technical Notes:

1. Fell, Dafydd (2005) 'Democratisation, Liberalisation, and Political Corruption in Taiwan.' The China Quarterly, 184 . pp. 875-893.
2. Wedeman, Andrew, "Looters, Rent-Scrapers, and Dividend-Collectors: Corruption and Growth in Zaire, South Korea, and the Philippines", The Journal of Developing Areas, Vol. 31, No. 4 (Summer, 1997), pp. 457-478
3. RGDP data from the Penn World Tables Ver. 7.0
4. Commodity price data from UNCTAD
5. USDMYR exchange rate from the US Federal Reserve