How Corruption distorts Fair Competition in Markets

How Corruption distorts Fair Competition in Markets. By: Sheron Sarah Nambuya DATE: 24 / 4 / 2016 1 Introduction Fair competition in markets is that which fulfils the profit motive, ensures that produced stocks are able to diminish through purchases. Consumers “compete to get the benefit provided by a good or service”, and “consumers are able to reject goods if they do not want them”. In addition, there is no information failure, no time lags “between the purchase of the private product and net benefit derived by the consumers”; and there are no externalities in terms of “effects on parties not involved in the market transaction”. Property rights are protected, and there are “incentives for entrepreneurs. But when corruption sets in, it distorts competition in markets, hence, market failure (economicsonline.co.uk). Corruption as “a crime in a market context” is more than paying bribes. It also involves collusion to create trade barriers, “sole source supply agreements”, “welfare reducing mergers or acquisitions”, (Soreide T.2014), “manipulation of prices”, “cutting costs, influencing planning, securing protection from competition and avoiding controls”. These place “risks along the value chain” and depend on factors such as the nature of business sector, “tender procedures, size of contracts, technical and financial complexity, haste in processes and trust in business practices of competitors (Soreide 2007). Although market distortions “happen for a whole range of reasons than corruption, the “most `attractive’ forms of corruption are the ones that distort the positive outcomes of competition” (Soreide 2014). Overall, this essay explains how corruption distorts competition in markets. A conclusion will be made. How Corruption distorts Competition in Markets Through State Capture and Political corruption, decisions are subjected to “political judgement”, to make “legitimate excuses” in favour of firms in which politicians hold direct or indirect stakes, to benefit from incentives such as tax cuts 2 and gain sole market power, to the prejudice of firms that do not wield such influence. Even where independent competition authorities are functional, corruption causes interference by politicians, to influence “the award criteria in big procurement decisions” in respect to, for example, infrastructure contracts, “to keep trade politics open for modifications” (Soreide 2014), hence, distorting competition in markets. Also, legislators pass laws that favour firms which are able to pay bribes or exert influence; and so is a judicial system which interprets laws in favour of bribe paying or influence wielding firms. Consequently, innovation is undermined because land, patent and trade mark rights are not protected amidst impunity by property grabbers. This cripples productivity as unprotected firms are driven out of business. Corruption as a means to gaining monopoly enables rich firms to buy or exert influence upon regulators to “preserve a monopoly on their position”, through trade barriers, “propose a merger, acquisition or enter into exclusive supplier agreements”, fix prices, or collude with a “a procuring entity” to “allow it to operate a cartel” (Soreide 2014), to the detriment of honest firms. To recover transaction costs incurred in exerting influence and paying bribes, monopolies regard such costs as production costs that are passed on to consumers in form of high prices, and inferior quality goods, hence, exploiting consumers who have no alternative. This distorts competition by “creating markets for goods that do not respect the law of demand” (Soreide 2014), as honest firms are pushed out of business. Through collusion, Corruption promotes bid rigging and submission of sham bids. Bribes paid by losing bidders, are regarded as production costs which are “passed on to consumers in form of high prices, when the losing bidders eventually win the bid to supply goods or services” (legalworlfinance.com), while competent and honest bidders lose business. 3 Moreover, corruption in public procurement poses “different corruption risks” at “each step of the sector value chain” that “involves different player”, creating “profit-making incentives among market players”. Consequently, such risks distort competition through the unfair allocation of contracts to firms that are able to corruptly influence decisions (Soreide 2014). Corruption weakens anti-corruption barriers by “undermining integrity safeguards through deviation by decision makers from codes of conduct”, non disclosure of financial interests”, like “political party financing”. It creates lack of transparency and denial of access to information in respect to business decisions and processes. This renders consumers and competing firms vulnerable to exploitation, amidst increased risks, as “whistle blowers are exposed to retaliation” (Soreide 2014), hence, impunity and distortion of competition in markets. In privatisation, corruption is used as a tool “to privatise market power” together with “the privatised entity that is up for sale” (Soreide 2014), by offering corrupt inducements for a favourable outcome, hence, distortion of competition in markets. Also, monopoly of power and unchecked discretion, minus accountability (Klitgaard 1988), in the decision-making function, coupled with a low risk of being detected and punished, distort competition. However, an increased risk of punishment may lead to higher bribes because “firm`s intrinsic profit-making incentives remain the same” (Soreide 2014). Corruption also distorts competition in markets through information asymmetries, for example, in the procurement of customised military purchases in which contracts are large and also complex, “with a lot of details kept confidential” (Soreide 2014). Limited access by outsiders makes such information vulnerable to manipulation by corrupt actors who inflate procurement prices for private gain. Also, “mismatches between information supposed to be present at planning and decision-making” stages and “lack of a full overview of financial matters, future demand for services or technical obstacles” provides a leeway to corrupt actors to deviate “from previous decisions” and inflate project size and total price (Soreide 2014). 4 Corruption also distorts competition through law enforcement asymmetries, exhibited by lack of political will for effective anticorruption enforcement. An example is the Al Yamamah case (the guardian.com), condoned by the British Government. Such law enforcement asymmetries characterised by the lack of action upon violating firms like BAE Systems gives leverage to such firms to operate at unequal terms, hence, uncompetitive practices in international trade. Also, through corruption, secrecy agreements are made between service providers and corrupt actors, to keep illicitly acquired wealth in safe and tax havens, enabling corrupt actors to plough back illicit wealth into investments and bargain for market power, to the prejudice of struggling firms. Noteworthy, tax evasion creates “damaging chain effects” that result into “significant losses in state revenues” and “cuts in public spending”, with a “risk of higher unemployment and civil unrest”. These “threaten framework conditions for productivity” (Soreide 2014), hence, distorting competition in markets. All the above thrive against a background where: “Grey zone practices” leave some actors confused as to what practices qualify as corruption, coupled with “the difficulty of providing proof of crime” (Soreide 2007 p.2). The application of diplomatic negotiations in exerting “pressure on foreign governments in procurement matters” (Soreide 2014), which despite market distorting consequences, is not regarded as corruption. Legal definitions “of corruption laden with words” like “improper, undue” are vague and accelerate “certain practices by market players” who are “uncertain as to whether a particular act complies with the law or not; like the issue of facilitation payments (Soreide 2014). Tender situations have “forms of corruption”, making it look “as if all rules are respected”, while in practice, the “choice of technology or prequalification and invitation to tender” are “tainted with biased discretion in the selection process and secret agreements about exposit contract modifications” (Soreide 2014). 5 In bilateral negotiations where corruption is “hidden as a legitimate deviation from the rules”, it catalyses the making of “an excuse to set standard rules aside” (Soreide 2014), hence distortion of competition in markets. Competition authorities which are better placed to “reveal market distortions” through their legal mandate, “say nothing about corruption” (Soreide 2014), hence exacerbating the problem. Conclusion To mitigate risks; Improve collaboration between competition authorities and criminal law investigators and the scope of competition authorities` mandate to escape the “catch-22 situation” (Soreide 2014); Improve business climate; differentiate between “welfare improving political decisions and those that are made to improve individual firms” (Soreide 2007); Address the issue of grey zones, and seek “innovative ways to design solutions” by paying attention to the “different ways in which firms might influence their competitive advantage through corruption” (Soreide 2007 p.2); Reform procurement procedures and anticorruption efforts to cater for many types of “business related corruption” rather than rely on rules to fix procurement corruption (Soreide 2007); Assess risks “along the whole sector value chain” by avoiding preoccupation with “tender related corruption only” (Soreide 2014); Hold both directors and firms accountable; Impose disclosure requirements for “certain kinds of mergers and acquisitions” as is in the US under the Hart-Scott-Rodino Act (legalworlfinance.com); Strengthen information sharing and international cooperation; enable access to information; ensure that sanctions do not distort competition sought to be protected; Debar violating firms for a specific self cleaning period, to enable equal treatment with trustworthy firms (Soreide 2014); 6 Trace, seize and repatriate illicitly acquired wealth; impose fines on tax evaders that do not further undermine competition; Identify and address the root causes of corruption in markets, for effective implementation to mitigate corruption`s distortionary impact on competition in markets. 7 Bibliography Economicsonline.com Available at www.economicsonline.co.uk/.../markets/competitive_markets.html Accessed on 20/4/2016 Legal Worldfinance.com Available at www.worldfinance.com Accessed on 20/4/2016 Soreide, T. (2007). Competition and Corruption: What can the Donor Community do? U4 No. 8 Soreide, T. (2014). Corruption and Competition: Fair Markets as an Anticorruption Device. The Guardian Available at www.theguardian.com/bae.files/page/0,2095831 Accessed on 21/4/2016 8