Acton Commentary

Corruption, Finance, and Developing Nations: A Private Banking Solution


Since its creation in July 1944, the World Bank has poured billions of dollars in loans and aid into developing nations' economies. In 2005 alone, World Bank loans totaled approximately $25 billion. Given the sums involved, it is hardly surprising that questions are increasingly being raised about the results of these direct wealth transfers.

Even the World Bank's strongest defenders concede the outcomes have been mixed at best. The Bank's critics have long highlighted the fact that much World Bank assistance has ended up in the pockets of virtually every “president-for-life” that most developing nations have endured at some point in their history. The World Bank has uncovered more than 2,000 cases of corruption and related offenses associated with its projects since 2001 alone.

Now, however, signs are emerging that some World Bank officials have had enough and are pushing the corruption issue to the forefront of the Bank's work. This involves recognition that corruption is, at its heart, a moral problem.

Corruption is a moral evil inasmuch as it involves one person freely choosing to betray his legitimate and legal duties to another person or organization in order to reap personal benefit. This may explain why the World Bank's President has not only made corruption an organizational priority, but has also addressed this theme at meetings with representatives of Indonesia's Muslim communities and at a Vatican-organized conference on corruption.

While giving this attention to corruption is important, it is surely reasonable to ask whether it is time to address an associated issue: the tendency of government-to-government loans or international institutions-to-developing nation-government loans to create incentives for corruption.

Under international law, the principle governing these loans is that the state, as the embodiment of a nation's sovereignty, holds liability for any debt contracted by national governments and that this liability is passed on from government to government. There are good reasons for this. First, violating this principle could establish precedents allowing a government to repudiate a previous government's debts simply because they did not agree with the loans. Second, debt-repudiation damages a nation's international credit worthiness and hence access to foreign capital.

The problem is that corrupt regimes have used this principle to avoid personal accountability for that portion of World Bank financial assistance they have siphoned off for themselves. Presently, the number of prosecutions of such individuals is tiny. Oddly enough, some Western governments appear reluctant to press this matter, even pressuring the World Bank to “not impose new conditions related to governance and anticorruption on its loans.”

Recovering these funds and punishing offenders is essential as a matter of natural justice and upholding rule of law. Equally important, however, is finding alternative methods for channeling the developed world's capital to the growing number of private businesses in developing nations, such as China and India.

Here a case may be made for making it easier for Western private banks and financial houses to invest in these fledging enterprises. Unlike government and international organization bureaucrats, private financial institutions have considerable incentives to avoid lending capital to corrupt regimes and every incentive to lend capital to profitable private businesses in developing nations. For, unlike domestic governments and international organizations, private banks do not enjoy the luxury of being able to raise taxes or demand more inter-governmental assistance to absorb bad loans. Private financial institutions have to answer to their shareholders for the success — or otherwise — of their investments.

Encouraging private investment does not mean attempting to create risk-free investment climates in developing countries. There are no “risk-free” environments. But one step forward would be for lawmakers to diminish the bureaucratic bottlenecks that place government officials in positions where they can demand bribes before permitting private loans to be made to private businesses in developing nations.

Public officials' imposition of literally purposeless restrictions on private exchanges costs them nothing, but creates perverse incentives for their private counterparts to bribe their way around such restrictions. Hence, it is little wonder that many private financial institutions, knowing their most important asset is their reputation for integrity, avoid the problem by declining to invest in such environments.

The path to creating sound capital-investment environments in developing nations will be long, involving the difficult tasks of sound moral formation and bureaucracy-reduction. If, however, such measures are accompanied by reductions in government-to-government loans and an associated rise in capital-investment by private financial institutions, corruption will almost certainly diminish significantly. And that would be a moral and economic victory for all.