Light regulation and growing prosperity are the best ways to make citizens more law-abiding. Turning law enforcement into a spectacle doesn't really serve that goal
This article originally appeared at Bloomberg
During a meeting of Ukraine's cabinet today, the head of the country's Emergency Situations Service and his deputy were handcuffed and led away in front of television cameras as a demonstration of the government's seriousness about rooting out corruption. While a crackdown is sorely needed in Ukraine, the size of a country's shadow economy depends less on such theatrics than on economic performance.
The Emergency Situations Service officials in Ukraine, Sergiy Bochkovsky and Vasyl Stoietsky, are accused of accepting kickbacks when purchasing equipment for their service. Although Ukraine has passed laws to make government procurement more transparent, the Interior Ministry claims the entire leadership of Bochkovsky's service, including heads of regional departments, was involved in the scheme.
The current Ukrainian government came to power on an anti-graft platform after the uprising against former President Viktor Yanukovych's corrupt regime. Now it has to convince creditors that it is fixing a moribund economy in which the shadow sector accounts for as much as 50 percent of official output. The story that Finance Minister Natalie Jaresko has been telling on a recent foreign tour is that the country arrests three to five corrupt officials a day, and that its newly-created anti-corruption agency is staffed with 700 people on salaries commensurate with those of their Western counterparts.
In choosing this noisy, TV-friendly way of fighting corruption, Ukraine follows the example of Georgia and Poland in the 2000s, as well as the more recent experience of Romania, where the head of a European Union-backed anti-corruption agency was arrested on graft charges this month. A crackdown on tax fraud in Romania helped identify more that 2 billion euros ($2.1 billion) in unpaid taxes, about 1.1 percent of economic output. In the process, 1,130 people, including former officials, have been hauled off to prison.
Such spectacles, however, invariably increase perceptions of corruption. Romania was ranked 69th out of 174 nations on Transparency International's Corruption Perceptions Index last year, down from 43rd in 2013, before the campaign started. Poland, which also formed a high-profile anti-corruption bureau with broad powers and did its best to publicize arrests, also managed to convince its citizens that it had a bribery problem: In 2013, 82 percent of Polish respondents to a Eurobarometer survey said corruption was widespread in their country, and 92 percent said bribing officials and using connections was the easiest way to obtain certain public services.
Do these methods also work to shrink the so-called non-observed economy? That's far from certain.
The most widely used estimates of countries' shadow economies are based on the methodology developed by Friedrich Schneider of Johannes Kepler University in Linz, Austria. It extrapolates the biggest parts of the underground economies -- undeclared work for cash payments and income under-reporting, which can both result from corruption -- from a range of official indicators. I have compared data that Schneider and the consulting company AT Kearney (with Schneider's help) obtained for European economies in 2003 and 2013 (the latest year for which such data are available), and found that shadow economies as a percentage of gross domestic product shrank everywhere in that 10-year period:
That may be because the size of the shadow economy is highly correlated with per capita GDP: In 2013, the correlation coefficient was -0.87. The wealthier a country, the smaller its shadow economy in terms of GDP share. In several papers, Schneider suggested that increasing economic prosperity makes it unnecessary for people to supplement their incomes in the shadow economy. That explanation works well for bribes, too.
It's pointless to pay the employees of an anti-corruption bureau high salaries when other public employees make almost nothing officially and derive most of their income from slush funds or corrupt schemes, as is too often the case in Ukraine. Televised arrests are probably less helpful in reducing the size of the shadow economy than deregulation, which cuts the number of public services for which bribes can be extracted. And getting housewives and tourists to spy on tax-evading businesses, as Greece recently suggested, won't work as well as making the taxation level compatible with these businesses' survival.
In the end, light regulation and growing prosperity are the best ways to make citizens more law-abiding. Turning law enforcement into a spectacle doesn't really serve that goal.