28 Mar 2005  Research & Ideas

Should I Pay the Bribe?

How should you handle corruption in your markets? On the heels of a recent Harvard Business Review fictional case study on corruption, HBS professor Rafael Di Tella lays out the not-so-black-and-white issues in this Q&A.

 

At Harvard Business School, one of professor Rafael Di Tella's areas of study is how political corruption and common crime can be controlled in a variety of contexts. So it was only natural that Di Tella would be asked to comment when the editors of Harvard Business Review created a fictional case around the topic of extortion.

"The Shakedown" looks at the conflicts faced by the owner of a software development center in Kiev. Pavlo Zhuk, the U.S.-based co-owner, is notified by his partner that their Kiev office has been visited by Ukraine Tax Authority agents demanding payment of late taxes. They have been given one week to pay. Zhuk himself was involved in paying bribes to expedite the establishment of phone lines for their business, shortening the process to a few weeks instead of years, and has even admitted he is amenable to paying "so-called facilitation payments to get bureaucrats to do their jobs, especially if that's what everyone else does." However, the promise of "serious consequences" if payment isn't made sounds more like extortion. Zhuk doesn't want to shutter the business, but also wants to act as ethically as possible.

Di Tella discusses the case and his own research.

Cynthia Churchwell: You have been studying the impact and workings of corruption for several years. What spurred your interest in this area?

Rafael Di Tella: I was born in Argentina, need I continue...?
I think I was always interested in politics and somewhat frustrated by the "explanations" offered for the country's economic and social problems. One of the more standard arguments was that corruption was the cause of all our problems. It seemed that we could become rich by becoming good. Obviously, this coincidence was quite nice but also somewhat suspicious.

Q: What countries and corrupt activities have you studied? Have you been particularly surprised by anything you have learned? What trends are you seeing?

A: My research does not have a geographic focus, although the experiences of Europe and the U.S. as well as that of Latin America have been more salient than others.

I've been surprised by how little progress we have made with the standard economic model of incentives (to fight corruption). For example, I don't think we could have predicted the little use we have for strategies that would pay high salaries in bureaucracies to deter corruption.

The biggest trend I see is the increased interest in talking about corruption. This is not the same as saying that people are more interested in reducing corruption. I think there is quite a lot of evidence suggesting that they are not. But people are certainly interested in telling other people how worried they are about corruption. It's a bit like jewelry: It makes people feel distinguished.

Q: Do you have a sense of the overall impact corruption has worldwide and on local economies?

A: No. There are countries that can grow a lot with corrupt governments and others where corruption is quite detrimental to economic progress. It really depends on the form of corruption and how markets are organized.

Q: What negative impact could paying bribes have on managers, even in countries where bribery is common?

A: It really depends on the different cases. In general, I would say that corruption exposes the managers and the organizations they work for. But it may also be quite profitable. And, as I explain in the comment to the HBR case, it may sometimes be unavoidable.

Q: How can managers avoid paying bribes and still protect their business from extortion? Is there any middle ground between the options of pay or leave?

I've been surprised by how little progress we have made with the standard economic model of incentives.

A: Again, the answer depends on the cases. But in general, in some markets there is no way of avoiding payment of bribes, except by exiting the market.

Q: Please tell us about your initiative to create a joint center between Harvard and Yale to monitor corruption. What will its mission be and how will it operate?

A: In many countries corruption accusations are used politically. Thus, the judiciary system is often an instrument of influence rather than a source of justice. In some cases, the accusations are so ridiculous that they are laughable. In one case, a former official at the economy ministry was accused of using the Net Present Value method. Yes, that was a key part of the evidence that was cited in the sentencing.

Still, these accusations have a cost to the politicians, both in terms of the monetary cost of the legal defense efforts and in terms of the reduced esteem of the uninformed public at home and abroad.

My proposal is to have a group of former lawyers and former judges in the U.S. to review selected judicial sentences in other countries, and give them a grade. This would introduce some external checks on judicial systems that have become too politicized to be of any real use in the fight against corruption.

HBS Case Commentary: Rafael Di Tella

As any businessperson would do in this situation, Zhuk will pay off the UTA [Ukraine Tax Authority] officials. After all, he wouldn't be breaking the law if he did so. The situation clearly suggests that Zhuk is a victim of extortion. According to most nations' laws, succumbing to extortion isn't a crime. So Zhuk will pay off [UTA special agent] Simonenko. He will consider the bribes an additional tax he has to pay for doing business in Ukraine and carry on with his pet project. Make no mistake: That's how the situation would play out in real life. If a businessperson doesn't pay officials when he is a victim of extortion, he doesn't have the stomach to do business in developing countries.

But should Zhuk pay off the officials? That's tougher to answer. I know what Zhuk will do; I don't know what he should do, because that's a moral issue, and we don't know from the case what Zhuk's morality dictates.

Let's think of a framework that might help us. Start by imagining a continuum of corruption cases. At one end, there is extortion of the Simonenko kind. At the other, there are money-laundering schemes that allow businesspeople in cahoots with local politicians to enrich themselves without having to invest in a company. Businessmen like Zhuk usually tell themselves that while they may have to pay off politicians and officials, they would never get involved in rackets of the second kind. Fair enough.

What's interesting is what companies do when they are in the middle of the continuum. Let's say you are a businessperson who wants to do business without bribing officials. One day, you find that a rival company is bribing bureaucrats for favors that are giving it an unbeatable advantage. You realize that if you don't get the preferential treatment your rival is buying, you're going to have to leave the country. In an economic sense, your choices are identical to those Zhuk faces: pay—or quit.

Under those circumstances, the end result will also be the same: Like Zhuk, you will pay a bribe. You'll talk to the corrupt bureaucrat and demand to be treated the same as your rival. When the official says he can extend favors to you only if you agree to do him favors in return, you'll agree. You'll find it easy to justify these favors to yourself by saying that you were the victim of an extortion demand by the bureaucrat. Thus, companies that start paying bribes are actually on a slippery slope. They justify extortion payments, and they justify bribes by saying they're doing only what their rivals are doing. And then…I'm not sure where they will stop on the continuum.

That worries me, because first, it means companies' moral standards are going downhill. Second—and this is something most firms don't realize—companies create a bad business environment by indulging corrupt politicians. When organizations are corrupt, they lose legitimacy. As a result, people demand more regulation, more taxes on companies, and more harassment of firms. That sets off a vicious cycle of policy intervention—and more corruption. It is up to Zhuk to decide what he wants to do: create one software center in Ukraine and risk damning his business in people's eyes, or work to increase the legitimacy of Ukrainian business, even if that means pulling out.

A word of caution. Talking about corruption in emerging countries has become too fashionable. It has few direct benefits and many indirect costs. Since the judicial systems in most developing countries are highly politicized, real—as opposed to rhetorical—progress is unlikely. Real change requires judicial reform, which is hard and takes time. No amount of talking about corruption and bribery is going to change that. This is why I recently proposed the creation of a Harvard-Yale Judicial Observatory. It will consist of a group of law academics and practitioners who can pass judgment on high-profile legal rulings that people suspect are politically motivated. That will change the incentives facing politicized judges and reduce idle corruption talk, and it may even improve the quality of politicians in emerging countries.

Excerpted with permission from "The Shakedown (HBR Case Study and Commentary)," Harvard Business Review, Vol. 83, No. 3, March 2005.

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About the author

Cynthia D. Churchwell is a business information librarian at Baker Library, Harvard Business School, with a specialty in the international economy.