Corruption has devastated Russia's attempts to create a prosperous market-based economy but has had less impact on Poland's conversion to capitalism. Frye suggests that effective bureaucratic reform played a key role in Poland's economic transition and suggests Russia might also benefit from public sector reforms.

Stabilization, privatization, and liberalization dominated early discussions of post-Communist transformation. But somewhat surprisingly, corruption has recently emerged as perhaps the most important obstacle to economic reform. While the experiences of Russia and Poland drive home this point, they also reveal very different stories about the development and implications of corruption for their respective economies. The lessons of post-Communist societies suggest that practical steps can be taken to minimize the corrosive effects of corruption on the development of market economies.

Analysis of corruption in Russia and Poland, as well as elsewhere in most of Eastern Europe and the new independent states of the former Soviet Union, should begin with an understanding of how state bureaucracies are organized. This is necessary because corruption undertaken by so-called "disorganized" bureaucracies causes greater economic damage than corruption undertaken by "organized" bureaucracies.

Think of a business person who needs 10 different permits from the state to make her product. Under a scenario of disorganized corruption, 10 different bureaucratic agencies have the power to issue permits needed to produce the good, and therefore each agency behaves like a monopolist. Each agency sets the price (read bribe) for its permits to maximize its individual revenue. Due to the number of independent agencies issuing different permits, they cannot coordinate their actions and charge high prices. As the price for permit 1 increases, however, demand for permit 2 falls. This drop in demand for permits 2 through 10 reduces overall demand, and, in turn, reduces each bureaucrat's revenue. The business person also suffers under disorganized corruption because she cannot pay all the bribes asked of her, does not produce the good, and receives no revenue.

Under a scenario of organized corruption, one agency has the power to issue all 10 permits needed by the business person. In this case, the agency behaves like a joint monopolist and sets the price for permit 1 lower than under the previous scenario because it does not want to reduce demand for permit 2. In turn, the agency sets the price for permit 3 low so as not to reduce demand for permit 4, and so on. The key notion here is that raising the price for permit 1 reduces demand for other permits. While organized corruption still leads to a misallocation of resources, it is less disruptive for the economy than disorganized corruption because the business is able to obtain the permit and produce the good.

POLAND AND RUSSIA

I tested the scenarios described above by conducting surveys of about 250 shopkeepers in three cities in Russia and one city in Poland in 1996 and 1998 on a variety of issues related to bureaucratic organization and corruption. I found that bureaucracies were far more disorganized in Moscow than in Warsaw. On average, shopkeepers in Moscow were inspected by almost four different agencies whose officials came to the average shop 19 times per year. Shopkeepers in Warsaw were inspected by 2.6 agencies whose officials came to the shop only nine times per year. In addition, the average shopkeeper in Moscow had to visit 6.6 different bureaucracies to open his business, versus only 4.3 for Warsaw. Also, the shop registration process lasted 10 weeks in Moscow and less than four weeks in Warsaw.

As the numbers suggest, levels of corruption were higher in Moscow than in Warsaw. We asked shopkeepers somewhat discretely: "How often do you think that the average shopkeeper in your city has to pay bribes, on a scale of 1 to 5 (1, almost never; 2, rarely; 3, sometimes; 4, often; 5, almost always)?" The answer for Moscow was 2.9 and for Warsaw was 2.2 -- a difference that is statistically significant. We also asked shopkeepers to rate their biggest problems on a scale of 1 to 10 (1, small problem; 10, major problem). Moscow shopkeepers rated corruption at 7.4, while Warsaw shopkeepers gave it a 3.1.

To reduce corruption in Russia, an environment must be fostered where separate agencies no longer have the power to arbitrarily set the price for doing business. Indeed, looking within Russia, we find that cities that have streamlined the granting of business permits have lower rates of corruption. For example, bureaucracies were more disorganized in Ulyanovsk than in Smolensk. The average shopkeeper in Ulyanovsk had to receive permits from 6.1 different agencies to stay in business versus 4.4 for shopkeepers in Smolensk. Moreover, the average shopkeeper in Ulyanovsk had to receive 8.8 permits to open his store versus 6.2 in Smolensk.

As expected, corruption is a bigger problem for shopkeepers in Ulyanovsk than in Smolensk. Respondents noted that the average shopkeeper had to pay bribes more frequently in Ulyanovsk than in Smolensk (3.2 versus 2.6, using the five-point scale described above). Shopkeepers in Ulyanovsk rated the problem of corruption 6.3, but shopkeepers in Smolensk rated it 5.4 (using the 10-point scale described above). Again, we find that disorganized bureaucracies tend to produce disorganized corruption that inflicts significant costs on society. This suggests that reductions in corruption in Russia are possible and can be addressed through reform of the public sector.

CORRUPTION AND THE INFORMAL ECONOMY

The evidence from Poland and Russia suggests that corruption, whether organized or disorganized, can levy devastating costs on an economy. It reduces investment due to the potential for arbitrary actions by state officials. It also reduces competition by rationing permits to the highest bidder rather than to the most efficient user.

Corruption, however, also has a more subtle effect on economic reform through its impact on the informal economy. Corruption tends to swell the informal economy because business deals involving corrupt officials cannot be enforced in state courts and are rarely subject to official rates of taxation. Rather than operate in the formal economy, abide by legal rules, and pay taxes, business people who rely on corruption operate in the informal economy, break legal rules, and pay few taxes. As people pay fewer taxes, the state is less able to provide public goods necessary for economic growth.

By 1995, the informal economy had grown far larger in Russia and Ukraine than in Poland. Relying on rates of the use of electricity in different countries, one study estimates that the underground economy made up 42 percent of the GDP (gross domestic product) in Russia, 49 percent in Ukraine, and only 13 percent in Poland. The dramatic expansion of the informal economy in Russia and Ukraine is somewhat surprising. Prior to 1989, the underground economy to the total economy was much larger in Poland than in the former Soviet countries.

PRESCRIPTIONS

Some scholars argue that certain national cultures are more conducive to corruption. However, we often see levels of corruption change in particular countries, even while the culture remains constant. Moreover, corrupt practices are strikingly similar across very different national cultures. Regardless of its culture, what country does not know corrupt customs agents? To reduce corruption, we should not look to national culture but to the incentives facing bureaucratic agents engaged in it.

The most common solution for reducing corruption is to curtail the discretionary power of state agents. For example, rather than let a bureaucrat grant a license to export a product (and allow him to accept a bribe for doing so), states should abolish export licenses and thereby allow economic factors to decide whether or not to export.

But this can provide only a partial solution since many important social functions cannot be left to the market. Moreover, it is often not politically feasible to assign some functions to the market rather than the state. Thus, if corruption is to be kept in check, public sector reform that makes the state more organized must operate in tandem with economic reform.