Regulation and corruption

Israel is once again at the center of a corruption scandal.

Olmert corruption trial (photo credit: MARC ISRAEL SELLEM/THE JERUSALEM POST)
Olmert corruption trial
Israel is once again at the center of a corruption scandal.
The damage to the country caused by our lawmakers’ lack of ethics is colossal. Corruption not only gradually destroys the trust between the government and the citizens but also reduces economic growth. When corruption is rampant and the government doesn’t appear to be ethical, local and international companies feel the environment isn’t safe enough for investment and will prefer to expand their businesses in less corrupt countries. In general, less corrupt countries have higher GDP, a lower unemployment rate and higher growth rate.
In terms of corruption, Israel ranks 37th out of 175 nations, according to Transparency International. Of the 34 OECD nations, Israel ranked 24th. The highest rated country was Denmark, with a ranking of 92, followed by New Zealand and the Nordic nations – Finland, Sweden and Norway. Why is Israel more corrupt than other countries? Are our politicians less ethical and trustworthy than Swedish and Danish lawmakers? The economic literature on corruption has emphasized the relationship between government intervention in the economy and the level of corruption. Already in 2002, the IMF Guide Promoting Good Governance and Combating Corruption claimed that “corruption thrives in the presence of excessive government regulation and intervention in the economy,” and adds that corruption increases “when the government provides goods, services and resources at below-market prices” or “when officials take decisions that are potentially costly to private individuals or companies.”
However, some of the least corrupt countries also feature a “big government,” posing a paradox for economists. One way to solve this seeming contradiction is to look at the type of government intervention. The leading cause of corruption isn’t so much the size of the government but more pertinently which aspects of the economy the government controls. A government that intervenes in income redistribution and welfare services but leaves the private sector relatively free to operate in a competitive environment has less chance to fall into corruption. This can explain why the “big governments” found in Nordic countries aren’t as corrupt as in Israel.
Professors Jonathan Hopkin and Andrés Rodríguez-Pose from the London School of Economics found that “the degree of regulation of private business activity is the strongest predictor of government corruption, and that high levels of public spending are related to low levels of corruption in countries where business activity is regulated lightly and unobtrusively.”
The World Bank’s Investment Climate Department (CIC) corroborated these results and found that corruption is positively correlated with restrictive regulation on businesses. After analyzing data from 2005 to 2008, the CIC concluded that the number of days needed to start a business impacts the level of corruption.
Countries that are the least “business friendly” and restrict competition through artificial barriers to entry in the market are also countries that show higher level of corruption.
According to the 2015 “Doing Business” index published by the World Bank Group, Israel ranks 40th in the overall ranking after losing two places since 2014. The index includes many areas in which Israel ranks shamefully: 53rd for starting a business, 121st for dealing with construction permits, 135th for registering property, 97th for paying taxes and 111th for enforcing contracts.
In comparison, the least corrupted countries are also ranked the best in ease to start a business. New Zealand ranks 2nd, Denmark 4th, Finland 9th and Sweden 11th.
More regulation and government control on businesses produce more corrupt practices. In order to gain extra business or other advantages, companies will try to bribe and influence lawmakers and regulators.
It would therefore by wise and prudent to reduce the temptation for lawmakers and free the private economy from government intervention. Such a move will not only put a damper on corruption, but will also foster the development of private businesses and enable them to support economic growth. If Israel doesn’t change the rules of the game it is most likely that more corruption scandals will emerge, further eroding public trust in Israeli bureaucrats and politicians.
The author is the director of the Jerusalem Institute for Market Studies.