Now that India is playing an ever larger role in the world economy, the issue of corruption, in both the private and public sectors, is coming into sharper focus. Two scenarios are possible: As India’s multinational corporations develop both economic and political muscle, they may act as a broom, sweeping corruption from the economic sphere. On the other hand, entrenched practices may prove the stronger force, and corruption could end up being a significant brake on India’s economic rise.

The License Raj and the Spoils System

One strand in the knot of corruption is the legacy of the License Raj, which ended in the early 1990s. The system created bureaucracies that were all but self-perpetuating. In a context where government workers were routinely underpaid, graft became an industry all its own. Civil servants were, and remain, anything but disinterested administrators.

Wharton management professor Jitendra Singh and Ravi Ramamurti, professor of international business at Northeastern University, have been studying the emergence of multinational corporations in emerging economies such as India. In late June, they organized a conference on this topic in Boston, co-sponsored by the Mack Center for Technological Innovation and the Center for Leadership and Change Management — both at Wharton — and the Center for Emerging Markets at Northeastern University. The conference’s papers will form the core of an edited volume which is planned for publication in 2008.

“In the bad old days,” Singh said in an interview, “particularly pre-1991, when the License Raj held sway, and by design, all kinds of free market mechanisms were hobbled or stymied, and corruption emerged almost as an illegitimate price mechanism, a shadowy quasi-market, such that scarce resources could still be allocated within the economy, and decisions could get made. Of course, this does not in any way condone the occurrence of such corruption. The shameful part of all this was that while value was captured by some people at the expense of others, it did not go to those who created the value, as it should in a fair and equitable system.”

The real failing, he said, “was a distortion of incentives within the economy, such that people began expending efforts toward fundamentally unproductive behaviors because they saw that such behaviors could lead to short-term gains. Thus, cultivating those in positions of power who could bestow favors became more important than coming up with an innovative product design. The latter was not as important, anyway, because most markets were closed to foreign competition — automobiles, for example — and if you had a product, no matter how uncompetitive compared to global peers’, it would sell. These were largely distortions created by the politico-economic regime. While a sea change has occurred in the years following 1991, some of the distorted cultural norms that took hold during the earlier period are slowly being repaired by the sheer forces of competition. The process will be long and slow, however. It will not change overnight.”

The costs of corruption are manifest in various parts of the economy. Inadequate infrastructure, of course, is widely recognized as a serious impediment to India’s advancement. Producing valuable goods is of limited utility if they cannot be transported in a timely fashion, for example. Transparency International estimates that Indian truckers pay something in the neighborhood of $5 billion annually in bribes to keep freight flowing. “Corruption is a large tax on Indian growth,” Ramamurti said in an interview after the conference. “It delays execution, raises costs and destroys the moral fiber.”

Corruption also cripples the effort to ameliorate poverty in India and to improve the country’s stock of “human capital.” The rate at which this happens varies tremendously from region to region. Edward Luce, for example, author of In Spite of the Gods: The Strange Rise of Modern India, notes that “Rates of theft vary widely from state to state in India, with the better states, such as Kerala and Tamil Nadu, getting more than 80% of subsidized government food to their poor. Meanwhile, in the northern state of Bihar, India’s second poorest with a population of 75 million, more than 80% of the food is stolen.”

Indian MNC’s as Change Agents

“A few Indian companies,” Ramamurti said, “such as the Tata group or Wipro, have taken the high road, but most firms find it impossible to get anything done without greasing palms.” Wipro, headed by Azim Premji, is India’s third-biggest global tech services provider (behind Tata Consultancy Services and Infosys). In Bangalore Tiger: How Indian Tech Upstart Wipro Is Rewriting the Rules of Global Competition, business journalist Steve Hamm writes that “Wipro is not just a company, it’s a quest.” That quest, according to some observers, is as much about moral rectitude as it is about business success. For example, according to Hamm, the company pays no bribes and has a zero tolerance policy for corruption.

“The paradox,” Ramamurti said, “is that even though India’s faster growth in recent years is the result of fewer government controls, most Indian managers would tell you that corruption has increased, not decreased, in tandem. How could this be? The explanation is that faster growth has created new choke points at which politicians and bureaucrats can extract payments, such as land regulation, spectrum allocation or college admissions — all of which have become much more valuable in [this century]. Faster growth has also raised the economic cost to firms of delays in public approvals, giving officials that much more ‘hold-up’ leverage over private investors.”

The Benefits of an Open Society

One of the inevitable comparisons in any story on rapidly developing economies is that between India and China. China has endured a spate of bad news in recent months regarding the impact of corruption and shoddy oversight on the quality of exported products — from cold medication that killed dozens of people in Latin America to toxic toothpaste to children’s toys coated in lead-based paint.

If China’s initial response was to attempt to characterize much of this as a Western conspiracy against Chinese products and businesses, officials were rather quickly goaded into taking serious action. In July, the government executed Zheng Xiaoyu, who headed China’s State Food and Drug Administration from 1997 to 2006.

“The good news in India, compared to China,” said Ramamurti, “may be that at least the most egregious forms of corruption are exposed by social activists or the media.” A more open society, by definition, provides more avenues for oversight, more empowered constituencies to ferret out and disseminate the truth when things go wrong.

“One big difference,” Singh added, “comes in the form of the legal system. In India, a firm can sue the government and win, which may not be as easy in China. Also, the public at large is much more vocal and active in India. Any group can file a Public Interest Litigation (PIL) against a firm, which will frequently get heard in court. Also, it is the case that corporate governance is stronger in India, on average, due to better disclosure and Securities and Exchange Board of India regulatory guidelines. This [is true] even though there are some fine Chinese firms, and some quite poorly governed Indian firms.”

Singh ticked off a quick list of additional cultural factors that are to India’s advantage: “A fierce — arguably sometimes to the point of being irresponsible — media, both the press and TV; a legal system descended from British Common Law like the U.S. which, while hardly perfect, does work reasonably well; [the existence of] certain rights … such as freedom of speech; strong links with the global economy through, though not solely due to, the non-resident Indian (NRI) community which provides global exposure; and a facility with English which makes for easier integration into the global economy.”

As in other countries, however, there is the nagging problem of money corrupting the electoral process and thereby short circuiting, or at least slowing, reform. “The business community and the public at large would welcome a reduction in corruption,” Ramamurti said, “but neither believes this will come to pass. Corruption is endemic in daily life, from things minor to major, and it has become the primary means of funding election campaigns.”

“The really serious problem here,” Singh stated, “is that the prevalence of corruption in the Indian economy may well have distorted cultural norms within the society. Yet I am also aware of countervailing forces, so I do not want to overstate the case. But to the extent that change in cultural norms will be needed to root out corruption, it will take a persistent, long, drawn-out effort. While economic change is easier to achieve, cultural change is much slower and more difficult. This is compounded by the rearguard actions of those who are beneficiaries of the status quo.”

Some Improvement; Some Distance Yet to Go

Transparency International monitors corruption globally and puts out an annual report which it refers to as the Global Corruption Barometer. The most recent figures from 2006 provide an interesting perspective on how Indians see progress in the area of corruption.

“Indians report a substantial reduction in the perceived level of corruption in a number of sectors,” according to the most recent report. “Improvements encompass education, the legal system/judiciary, media, parliament/legislature and utilities. It should be noted, however, that Indian respondents still indicate that the majority of sectors highlighted are significantly affected by corruption. These improvements should therefore be understood as a positive sign of progress, but not an indication that the problem of corruption has been solved.”

How much is left to be done? Some three out of four Indian respondents, on the question of the degree to which their government is fighting corruption, answered that the government was either “not effective,” “does not fight at all,” or “actually encourages” corruption.

Where does business fit into this? Asked to rate the impact of corruption on various spheres of their lives — on a scale of one to four, from “not at all” to “to a large extent” — Indians identified “political life” as the sphere most significantly impacted (2.9), and personal and family life as the least impacted (2.3).They put the business environment squarely in the middle (2.6).

What institutions are respected? Rating the impact of corruption on different sectors and institutions (on a scale of one to five, from “not at all corrupt” to “extremely corrupt”), Indians identified “political parties” (4.2) and “police” (4.3) as the most corrupt institutions, with business again near the middle (3.2). The least corrupt institution? The military, at 1.9.