Corruption as a Business Risk in Emerging Markets

Corruption increases an economy’s volatility, and greater volatility leads to increased risk. Part of the attraction of investing in emerging markets is the higher-risk/higher-return ratio, but you may not want to take on the added hassles that often come with an investment in a highly corrupt economy. On the other hand, valuations may improve if the corruption climate improves.

One reason corruption adds to risk is that its cost is unpredictable. Business people know what they owe in taxes and fees. Governments publish tax tables and fee schedules. What entrepreneurs don’t know is what they have to pay in terms of kickbacks and bribes. Those extra expenses can’t be deducted from their income taxes, either. They may not even be able to tell their business partners about this unexpected expense, causing problems when the other parties want to know why the bank accounts don’t have more cash. These complications discourage some people from starting a business in the first place, slowing down economic growth.

Corruption causes other problems for businesses. For example, if a company has a lot of unreported income and expenses, attracting investors or receiving loans may be difficult. After all, the company’s financial statements won’t be a fair representation of its business. If investors know that corruption is widespread in an economy, they look at any information they receive with suspicion.

Transparency International, a international coalition fighting corruption, found that people are willing to pay higher prices if they don’t have to deal with corruption. That’s not surprising, really. No one really likes the hassle, the uncertainty, or the risk of being caught that comes with a shakedown for cash. People pay extra to avoid it.

The world’s perennially least corrupt countries include Denmark, New Zealand, Singapore, and Sweden. None of these is a low-cost place for doing business and all of them are prosperous.

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