Firms that get bigger and more profitable reduce the share of their revenues that are skimmed off by officials in bribes – the ‘bribe rate’. Superstar businesses that can relocate easily are particularly likely to experience falling bribe rates as governments don’t want to see them move elsewhere.

These are the central findings of research by Jie Bai, Seema Jayachandran, Edmund Malesky and Benjamin Olken, which is published in the February 2019 issue of The Economic Journal. Their study analyses survey data collected over a five-year period from more than 10,000 firms in Vietnam, a country in which private businesses have flourished since the late 1980s yet where 52% of them report companies in their sector being asked for bribes.

The authors conclude that policies that support the growth and mobility of businesses hold the promise of sparking a ‘race to the top’ in the eradication of corruption.

It is widely understood that government officials demanding bribes from businesses hobbles otherwise healthy markets in many developing countries. Companies must divert scarce resources away from valuable investments to pay this extra ‘tax’ to bureaucrats just to obtain business permits or basic services. So how can the share of business revenue lost to bribes be reduced?

Economists have long observed that corruption more acutely afflicts markets in developing countries, where firms are smaller, than in richer countries. Even within countries, smaller firms pay a higher bribe rate on average. But because lower bribe rates are also likely to enable firms to grow faster, previous research has largely been unable to disentangle cause and effect.

The new study’s first major contribution is to show that firm growth in Vietnam has led to a reduction in corruption. The authors do this by estimating how province-level bribe rates respond to the local growth rate, predicted based on its industrial composition. They find that a doubling of employment in an industry leads to a 35% reduction in the bribe rate within that industry.

The second contribution is to explain why the impact of firms getting bigger and more profitable is to reduce the bribe rate. The reason, according to the authors, is that these firms are more attractive and important for a government to retain. Officials fear that if they ask for too much, the superstar businesses will relocate, so the officials lower their ‘ask’ of these firms.

These findings provide an endorsement of Vietnam’s move in the 1990s to decentralise business-government interactions to the provincial level and to encourage provinces to compete to provide the best environment for business.

Indeed, the data source used in the study is named the ‘Provincial Competitiveness Index’ Survey, as one of its other uses is to create a league table that ranks provinces by their attractiveness for business. When firms have access to and make decisions based on this information, provincial governments have an incentive to clean up their act and climb up the league table.

The dynamic explained above requires that businesses have a credible threat to relocate if government officials demand too much in bribes. The authors present a series of fine-grained analyses that show that this is indeed the case.

First, firm growth reduces the bribe rate more strongly among firms that hold land certificates than among those that do not. Having a land certificate lowers the cost of moving since the company has the right to sell the land from which it is moving away; without a certificate, it would forfeit the value of the land.

Second, growth reduces bribe rates more among firms that operate in multiple provinces. This is probably because it is cheaper to scale back operations in one province and increase operations in another than it would be for a firm to establish an entirely new provincial branch.

Taken together, this evidence lends powerful credence to the proposition that increasing firm growth and mobility reduces the burden of corruption. While this study focuses on Vietnam and each country’s business environment is unique, the findings may apply to other countries in which sub-national governments play a key role in interfacing with businesses, such as China.

Firm Growth and Corruption: Empirical Evidence from Vietnam’ by Jie Bai, Seema Jayachandran, Edmund Malesky and Benjamin Olken is published in the February 2019 issue of The Economic Journal.