From lobbying the state to capturing it

THE literature on state capture focuses to a great extent on former Soviet countries, but this type of corruption can be found in other parts of the world where politics and business have very close ties and transparency is lacking.

Transparency International defines state capture as “a situation where powerful individuals, institutions, companies or groups within or outside a country use corruption to shape a nation’s policies, legal environment and economy to benefit their own private interests”.

According to World Bank economists Joel Hellman, Geraint Jones and Daniel Kaufmann, the dominant challenge in designing reform strategies in the initial stages of transition in Eastern Europe and the Soviet Union was to reduce and reorient the state’s role in the economy. The strategies of liberalisation and privatisation were intended to change the way in which the state interacted with firms.

Little attention was paid to the flip side of this relationship — the ways in which firms exert influence on the state. Such forms of influence had a powerful impact on the pace and direction of reforms, the design of economic and political institutions and, ultimately, on the general quality of governance.

A “capture economy” is one where public officials and politicians privately sell underprovided public goods and a range of rent-generating advantages to individual firms — at enormous social cost to the overall enterprise sector.

Hellman, Jones and Kaufmann’s research looks at three types of interaction between the firm and the state:

Administrative corruption: the extent to which firms make illicit private payments to officials to alter the implementation of administrative regulations on the firm’s activities;

State capture: the extent to which firms make illicit private payments to public officials to influence the formations of laws, rules and regulations; and

Influence: the influence firms have on the formation of laws, rules and regulations without recourse to illicit and non-transparent private payments to public officials.

The key distinction is the source of the rents and the rough distribution of those rents in each relationship.

The most advanced reformers have the lowest levels of state capture, as their progress in liberalising the economy, strengthening bureaucratic accountability and promoting political contestability constrain the extent to which individual firms can capture the state.

Partial reformers, both in terms of their political and economic transitions, may have made significant advances in liberalisation, privatisation and institutional reforms, but their concentration of political power and limitations

State capture is much more damaging than ordinary corruption

on political competition remain a concern.

To understand the economic cost of a captured state, one needs to just read the final report on the financial crisis inquiry commission of 2011, which concludes that the financial industry itself played a key role in weakening regulatory constraints on institutions, markets and products.

From 1998 to 2008, the financial sector spent $2.7-billion (R41-billion at today’s rates) in reported federal lobbying expenses.

State capture is much more damaging than ordinary corruption because state institutions fall under the de facto control of persons or networked groups that use the state for their own interests.

It affects the fundamentals of a democratic system.

Leoka is an economist at Argon Asset Management