Corruption Information

Cost of corruption

 

This section examines the cost of corruption in the infrastructure, construction and engineering sectors.


This webpage comprises the following sections:

  • Understanding the cost of corruption in relation to infrastructure projects

  • Quantifying the cost of corruption

  • Example of the effect of corruption on project costs

  • The relevance of the cost of corruption



Section 1

Understanding the cost of corruption

in relation to infrastructure projects



What is meant by the cost of corruption?

The cost of corruption in relation to a project is the total loss and damage that is caused by all corrupt activity on or in connection with the project.   When assessing such loss and damage, one needs to consider, as far as possible:

  • Each corrupt activity that has occurred on or in connection with the project.

  • Each stakeholder that has suffered loss and damage as a result.

  • The types of loss and damage that have been suffered by each stakeholder.

  • The amount of each type of loss and damage suffered by each stakeholder in respect of each corrupt activity.

The sum total of that loss and damage (which is unlikely to be wholly identifiable or quantifiable) may be said to be the cost of the corruption in relation to that project.  Consequently, calculating that cost is an extremely complex (and potentially impossible) process.



What types of corrupt activities may cause loss and damage?

Loss and damage may arise from a wide variety of corrupt activities which may take place on or in connection with a project.  These activities may include misappropriation of funds, bribery, extortion, fraud, cartels, collusion, embezzlement, abuse of power, trading in influence and money laundering.  The individuals who carry out these corrupt activities may include government officials, and officers and employees of the project owner, project funders, tenderers, contractors, consultants, sub-contractors and suppliers.  They may be acting either on their own behalf or on behalf of their organisations.  Corrupt activities may take place at any time during the course of the project, from the point where the project is being selected right through all phases of financing, design, tendering, execution, maintenance, operation, and dispute resolution.  (See How corruption occurs for a detailed account of the different types of corrupt activity that may occur on a project.)  Each of these corrupt activities may cause significant loss and damage.


What types of loss and damage may be caused by corrupt activity?


The types of loss and damage that may be caused include financial loss, environmental damage, loss of quality of life, personal injury and death.  Within these categories, there are various sub-categories.  So, for example, financial loss may arise from inflation of project price, increased maintenance and repair costs, damage to reputation, and legal fees.  These types of loss and damage will vary according to the individual stakeholder.


What types of loss and damage may be suffered by individual stakeholders?


Any project stakeholder may suffer loss and damage as a result of corruption in connection with the project.  These stakeholders may suffer loss and damage whether they are the perpetrator or the victim of the corrupt activity.  In some cases, a stakeholder may be the ultimate stakeholder to bear the loss and damage.  In other cases, a stakeholder may bear the initial loss and damage caused by the corruption, but may then succeed in passing on some or all of that loss and damage to another stakeholder.  In this case, where loss and damage is passed on from one stakeholder to another, care must be taken not to double-count the loss and damage but only to consider it where it ultimately falls.  The type of loss and damage suffered by individual stakeholders will depend on the type of stakeholder.  The following sections consider the types of loss and damage caused to:

  • the project owner

  • the project funders

  • construction companies, consulting engineering firms and suppliers

  • project officers and employees

  • government officials

  • members of the public.


Loss and damage to the project owner:  The following are the categories of loss and damage that may be suffered by the project owner as a result of corruption in connection with the project:

 

  • Theft of project funds:  Project funds intended for spending on specific projects may be misappropriated before ever reaching the intended project.  This can occur where there are inadequate controls to ensure that funding is used for the intended purpose.  The cost of such corruption is the amount of funds stolen, plus loss of use of the project.
  • Waste of project funds:  Project funds may be wasted where there is corruption in project selection or project design resulting in non-viable projects or projects which are unsuitable for the intended purpose.  An example of this is where a project is selected primarily because it is very large and capital intensive and so will provide ample opportunity for large bribes and/or misappropriation of funds, or because its location will benefit a corrupt party.  The result may be that the project is of no or little use to the public.  Alternatively, waste of project funds may occur where a project is over-designed so that it is too sophisticated for the intended purpose but with the corrupt intention that the over-design will maximise profits for the relevant corrupt parties.  Alternatively, a project which was viable and appropriate at the outset may collapse or be rendered unviable as a result of corruption which takes place during the structuring or execution of the project.  The cost of such corruption is the amount of funds wasted in paying for a project that was non-viable at the start or which subsequently became unviable because of corruption.

  • Increased price of projects:  Corruption may result in an inflated project price being paid by the project owner.  For example, corruption in the design phase may result in an overly expensive design being produced so as to give preference to a particular supplier.  Corruption in the financing phase may result in onerous financing terms being paid by the project owner.  Corruption in the tender stage for one or more project contracts may result in the corrupt winning contractor including the cost of the bribe in the contract price and/or additionally inflating the contract price because it knows that there is no genuine competition.  Corruption during project execution may result in an inflated final contract price due to the certifier being bribed by a consultant or contractor to approve fraudulent claims.  All or some of these types of corruption may occur in an individual project.  The cost of such corruption is the amount by which the project price is increased as a result of the corruption.

  • Increased maintenance, repair and replacement costs:  Corruption may result in the final product (for example, the completed road, hospital or dam) being dangerous or inadequate for the intended purpose.  This may be due to the corrupt supply of defective works, services and/or materials which have either been concealed from the certifier or been corruptly approved by him, or it may be due to the incompetence of the contractor who won the contract through bribery.   These defects may necessitate increased maintenance and repair works.  Alternatively, where corruption has resulted in a project which is unsuitable for the intended purpose, a replacement project may be required.  The cost of such corruption is the amount by which maintenance, repair and replacement costs are increased as a result of corruption, plus loss of use of the project.

  • Additional financing costs:  Corruption may result in the project financing costs being increased.  For example, corruption in the provision of financing (such as a bank paying a bribe to the project owner’s representative to approve the project financing) may result in the finance fees and interest charges being higher than market rates.  Also, any additional capital or operating costs of the project caused by corruption will need to be financed, and such financing will incur financing costs. 

  • Cost of bribes paid by the private sector project owner:  A private sector project owner may choose or feel compelled to pay bribes to a government official in a number of situations including: to obtain consent to proceed with a project, to obtain the necessary planning permits, to reduce environmental, social or safety and health conditions, to improve revenues from any purchase or use of its product, to reduce taxes payable on the project, and perhaps to prevent nationalisation.  In most cases, the project owner will succeed in recovering the cost of those bribes through the operating or other profits made on the project, so that the cost of the bribes will ultimately be borne by the consumer or end-user.  However, to the extent this is not possible, then the cost of the bribes will be a cost of corruption for the project owner.

  • Reduced operating profits:  A defective project may prevent the project from operating, or from operating to full capacity.  For example, a defective toll road may have to be closed for repairs and so will be unable to collect tolls for that period.  A defective power station may be unable to provide electricity and so will be unable to collect electricity tariffs until the defects are remedied.  The cost of such corruption is the financial loss suffered as a result of the reduced operation. 

  • Increased operating costs:  Corruption may result in the project owner being burdened with excessive operating costs.  This may happen, for example, where an officer of the project owner is bribed to agree to unduly favourable terms for the party operating the completed project.  The cost of such corruption is the amount by which the operating costs are increased as a result of corruption.

  • Loss of business opportunity and investment:  Corruption on a project may result in damage to the reputation of the project owner.  This may occur, for example, where the project owner is perceived to have failed to implement adequate anti-corruption measures both on the project and within its own organisation and/or where the project owner or its officers are suspected or convicted of corruption.   The resultant cost may be that the project owner may find it more difficult to find business partners or investors for its projects, or only on less favourable terms, due to loss of confidence in the competence or integrity of the project owner.

  • Damages for civil liability:  The project owner may incur civil liability to stakeholders who have incurred loss and damage as a result of corruption on the project.  For example:

    • Where project funds have been misappropriated, or where they have been invested in a white elephant project, the project owner may be sued by members of the public for loss or wastage of public funds.

    • If one of the project owner’s officers has been taking bribes to award contracts, other tenderers may sue the project owner to recover lost bidding costs. 

    • If the certifier on a project has been bribed to approve defective works which have resulted in injury to members of the public (e.g. the collapse of a bridge), those members of the public may sue the project owner. 

The basis of these claims would be that the project owner had a duty to implement proper anti-corruption measures both within its organisation and on the project, but failed to comply with this duty, and as a result caused loss and damage to other project participants and/or to members of the public.  The cost of corruption in this case would be the amount of damages payable by the project owner and any other civil remedy that may be imposed on it.

  • Fines for criminal liability:  The project owner may incur criminal liability for a number of reasons:  the project owner may have deliberately or recklessly perpetrated corrupt activity; or it may be held criminally responsible for corrupt activity perpetrated by one of its officers; or it may have failed to implement proper anti-corruption measures where it was legally required to do so.  The cost of corruption in this case is the amount of criminal fine that may be payable by the project owner and any other criminal penalty that may be imposed on it.

  • Legal fees:  Where corruption on a project has caused loss to the project owner (such as where the there have been corrupt financing terms, or over-design, or corruption in tendering or in the approval of inflated claims), the project owner may wish to take legal action to recover these losses.  Such legal action may involve considerable legal fees which may be irrecoverable.  Similarly, where the project owner is suspected of perpetrating corruption or failing to prevent corruption, it may incur considerable legal fees in fighting civil and criminal actions brought against it (as discussed above).  The cost of such corruption is the amount of irrecoverable legal fees payable by the project owner.

  • Loss and damage to individual officers and employees of the project owner:  The cost of corruption for individual officers of the project owner are discussed under “Loss and damage to project officers and employees” below.

 

Loss and damage to the project funders:  The following are the categories of loss and damage that may be suffered by the project funder as a result of corruption in connection with the project:

  • Total or partial loss of investment:  Corruption may result in the funder investing in a non-viable project, or in a project that is subsequently rendered unviable by corruption during the project.  This may occur, for example, where an officer of the project funder is bribed by the project owner to approve a loan to an unviable project, or where there is fraudulent misrepresentation by the project owner to the funder as to the viability of the project, or where the funder fails to carry out adequate due diligence on the project and so does not appreciate the potential for corruption which subsequently renders the project unviable.  The cost of such corruption will be the amount of investment that the funder is unable to recover.

  • Reduced profitability:  A project owner may bribe or collude with an officer of the project funder to provide project financing on terms which are unduly favourable to the project owner, such as lower financing costs.  The cost of such corruption for the funder will be the amount of revenue lost.

  • Cost of bribes paid by the funder:  A project funder may choose or feel compelled to pay bribes in a number of project situations, such as a bribe to win the financing contract or a bribe to secure more favourable financing terms.  In most cases, the project funder will succeed in recovering the cost of those bribes through the financing charges so that ultimately the project owner (and in public sector cases, the public) will bear the cost of those bribes.  However, where this is not possible, the cost of such bribes will be a cost of corruption for the project funder.

  • Loss of business opportunity and investment:  Corruption in the project financing terms or on the project itself may result in damage to the reputation of the project funder.  This may occur where the project funder is perceived to have failed to implement adequate anti-corruption measures within its own organisation, or to have failed to require anti-corruption measures to be implemented on the project, or where the project funder or its officers are suspected or convicted of corruption.  The resultant cost may be that the project funder may find it more difficult to find business partners or investment projects due to loss of confidence in the competence or integrity of the project funder.

  • Damages for civil liability:  The project funder may incur civil liability to stakeholders who have suffered loss and damage as a result of corruption in the project financing or on the project itself.  For example, where project funds have been invested in a non-viable project, or where revenue been lost due to corruption during the project, the project funder may be sued for failing to carry out proper due diligence on the project and/or for failing to require anti-corruption measures to be implemented on the project.   Alternatively, if corrupt activity by one of the funder’s officers resulted in the financing terms being unduly onerous for the project owner, the project owner may sue the project funder for damages.  The cost of such corruption would be the amount of damages payable by the project funder and any other civil remedy that may be imposed on it.

  • Fines for criminal liability:  The project funder may incur criminal liability for a number of reasons:  the project funder may have deliberately perpetrated corrupt activity; or it may be held criminally responsible for corrupt activity perpetrated by one of its officers; or it may have failed to implement proper anti-corruption measures where it was legally required to do so.  The cost of corruption in this case is the amount of criminal fine that may be payable and any other criminal penalty that may be imposed.

  • Legal fees:  Where corruption on a project has caused loss to the project funder (such as where there have been corrupt financing terms, or corruption on the project which has damaged the funder’s investment), the project funder may wish to take legal action to recover those losses.  Such legal action may involve considerable legal fees.  Similarly, where the project funder is suspected of perpetrating corruption or failing to prevent corruption, it may incur considerable legal fees in fighting civil or criminal actions brought against it (as discussed above).  The cost of such corruption is the amount of irrecoverable legal fees payable by the funder.

  • Loss and damage to individual officers and employees of the project funder:  The costs of corruption for individual officers of the project funder are discussed under “Loss and damage to project officers and employees” below.



Loss and damage to construction companies, consulting engineering firms and suppliers:  The following are the categories of loss and damage that may be suffered by construction companies, consulting engineering firms and suppliers (“contractor”) as a result of corruption in connection with the project:

  • Bribes paid in tendering by successful tenderers:  When tendering for project contracts, procurement officers may demand bribes, or the contractors may offer bribes, in order to win contracts.  The winning contractor may ultimately bear the cost of these bribes, or it will try to recover the cost of the bribes by inflating the contract price.  In the latter case, the cost of the bribe will ultimately be borne by the project owner (or, in the case of public sector projects, by the public).  

  • Bribes paid in tendering by unsuccessful tenderers:  A contractor that has paid a bribe to win a contract but which has not been awarded the contract will bear the cost of the bribe paid.  The amount of the bribe will be the cost of corruption to the contractor.

  • Wasted tender costs:  If the tendering procedures on project contracts are corrupt, then contractors which fail to pay a bribe will generally have no real chance of winning the contract and their tender costs will therefore have been wasted.  The cost of such corruption will be their tendering costs.

  • Increased contract operating costs:  Corruption may increase the operating costs of contractors.  For example, a contractor may choose or feel compelled to pay bribes or facilitation payments:

    • to obtain work permits and import licences
    • to receive contract payments due
    • to have legitimate or fraudulent claims approved
    • to have legitimate or unduly onerous environmental, safety or social requirements removed
    • to have defective works or services fraudulently approved.

These contractors may bear the costs of these bribes, but in many cases they will seek to recover the cost of the bribes by, for example, fraudulently inflating contract claims in which case the cost of the bribes would be borne by the project owner.  To the extent that they are unable to pass on the cost of these bribes, these bribes will be a cost of corruption to the contractors.

 

  • Loss of payment or profit:  Corruption may cause a contractor to lose payments or profits.  For example, a contractor may refuse to pay bribes to obtain work permits and import licences.  This may result in delay to the works and the imposition of liquidated damages on the contractor, thereby increasing its costs, or reducing its profit.  Alternatively, a contractor may refuse to pay bribes to obtain contract sums or approval of claims which are properly due.  This may result in the contractor not receiving payment for those contract sums and claims.  Alternatively, a project owner may fraudulently undervalue works, services or materials or fraudulently allege that works are defective, and may as a result refuse to make proper payments to the contractor.  In all such cases, the cost of corruption to the contractor will be the amount of sums which are properly due and which it does not receive as a result of the corruption.

  • Termination of contracts:  Where a contractor is proved to have won a contract through corruption, the project owner may be entitled to terminate the contract without any compensation to the contractor.  The cost of corruption to the contractor will be the costs incurred as a result of the termination, and the loss of future profit.

  • Loss of work:  Where it is generally known that there is likely to be corruption on a project, ethical contractors may decide not to participate in the project.  (This may extend to a sector or country as a whole so that ethical contractors withdraw from a whole sector and/or a country because of the prevalence of corruption.)  Where a contractor refuses to participate in a corrupt market, the cost of corruption will be the lost overhead recovery and profit which the contractor might have made.  This loss would need to be off-set against overhead recovery and profit from any other work which the contractor obtains elsewhere.

  • Loss of business opportunity and investment due to loss of reputation:  Corruption in the project may result in damage to the reputation of contractors who tender for or take part in the project.  This may occur where a contractor is perceived to have failed to implement adequate anti-corruption measures within its own organisation, or where the contractor or its officers are suspected or convicted of corruption.  The contractor may, as a result, find it more difficult to find business partners or to win contracts on other projects due to loss of confidence in the competence or integrity of the contractor.  The cost of such corruption would be the loss of potential overhead recovery and profit for the contractor.

  • Loss of business opportunity due to debarment:  Where a contractor or any of its senior officers are convicted of a corruption offence, this may result in the contractor being temporarily or permanently debarred from participating in certain public sector projects.  The cost of such corruption would be the loss of potential overhead recovery and profit for the contractor.

  • Damages for civil liability:  A contractor may incur civil liability to stakeholders who have suffered loss and damage as a result of corruption for which the contractor is responsible.  For example, where a contractor has paid a bribe to win a contract and has then included the cost of that bribe in the contract price, or where a contractor has fraudulently inflated a claim, the project owner may sue for recovery of the amounts paid as a result of the corruption.  Alternatively, where a contractor has fraudulently provided defective works, the project owner may sue the contractor for the cost of repairing those works and for any loss of profit in being unable to operate the works, and members of the public may sue the contractor for any loss and damage they have suffered as a result of those defects.  The cost of such corruption would be the amount of damages payable by the contractor and any other civil remedy that may be imposed on it.

  • Fines for criminal liability:  A contractor may incur criminal liability for a number of reasons:  the contractor may have deliberately perpetrated corrupt activity; or it may be held criminally responsible for corrupt activity perpetrated by one of its officers; or it may have failed to implement proper anti-corruption measures where it was legally required to do so.  The cost of corruption in this case is the amount of criminal fine that may be payable by the contractor and any other criminal penalty that may be imposed on it.

  • Legal fees:  Where corruption on a project has caused loss to the contractor (such as where the project owner has fraudulently alleged defective works, or where the project engineer has refused to certify claims without a bribe), the contractor may wish to take legal action to recover those losses.  Such legal action may involve considerable legal fees.  Similarly, where the contractor is suspected of perpetrating corruption or failing to prevent corruption, it may incur considerable legal fees in fighting civil or criminal actions brought against it (as discussed above).  The cost of such corruption is the amount of irrecoverable legal fees payable by the contractor.

  • Loss and damage to individual officers and employees of the contractor:  The costs of corruption for individual officers of the contractor are discussed under “Loss and damage to project officers and employees” below.

 

Loss and damage to project officers and employees:  The following are the categories of loss and damage that may be suffered by officers and employees who work for organisations which are involved in the project as a result of corruption in connection with the project:

  • Loss of income due to loss of employment:  Where corruption occurs on a project, it may result in the project collapsing, or in the termination of the contract of a particular company, or in a company incurring considerable losses so that the company is forced into liquidation or into making employees redundant.  In such cases, officers and employees of organisations affected by this corruption are at risk of losing their employment.  Similarly, where an individual officer or employee is himself suspected or proved to have been involved in corruption, this may result in him being dismissed and in finding it difficult to find other employment.  The cost of corruption in this case is the loss of earnings for the officer or employee.

  • Damages for civil liability:  An individual officer or employee of an organisation may become involved in corruption on his own behalf or on behalf of his employer.  In either case, the individual may incur civil liability to any stakeholder which suffers loss and damage as a result of the corruption.  The cost of such corruption is the damages which will be payable by the individual.

  • Imprisonment and/or fines for criminal liability:  An individual officer or employee of an organisation who becomes involved in corruption (whether on his own behalf or on behalf of his employer) may incur criminal liability.  The cost of such corruption may be imprisonment (which will also result in loss of earnings during the imprisonment period) and any fines which are payable by the individual.

  • Legal fees:  Where an individual officer or employee is suspected of perpetrating corruption or failing to prevent corruption, he or she may incur considerable legal fees in fighting civil or criminal actions (as discussed above).  The cost of such corruption is the amount of irrecoverable legal fees payable by the individual.

  • Injury or death:  Corruption on a project may lead to the injury or death of individual officers or employees.  This may occur, for example, where corruption has resulted in lack of safety measures or in defective works causing accidents.  Alternatively, an officer or employee who reports corruption or his suspicions of corruption, or is a witness to corruption, or who tries to blackmail a corrupt party, may be injured or killed.

 

Loss and damage to government officials:  The following are the categories of loss and damage that may be suffered by government officials as a result of corruption in connection with a project:

  • Loss of income due to loss of employment:  A senior or junior government official may lose office or employment as a result of corruption.  This may occur, for example, where a minister or other senior officer is found to have accepted or extorted bribes in exchange for approving projects or awarding contracts, or where a junior officer is found to have extorted facilitation payments in return for processing permits.  The cost of such corruption would be the loss in earnings for the official.

  • Damages for civil liability:  Where corruption by a government official has caused loss or damage to a project stakeholder, then the official may be sued by the stakeholder for any damage suffered.  This may occur, for example, where a tenderer failed to win a tender because of corruption by that official.  The cost of such corruption is the damages that would be payable by the official.

  • Imprisonment and/or fines for criminal liability:  A government official who becomes involved in corruption may incur criminal liability.  The cost of such corruption will be imprisonment (which will also result in loss of earnings during the imprisonment period) and any fines which are payable by the official.

  • Legal fees:  Where a government official is suspected of perpetrating corruption or failing to prevent corruption, he or she may incur considerable legal fees in fighting civil or criminal actions (as discussed above).  The cost of such corruption is the amount of irrecoverable legal fees payable by the official.

  • Injury or death:  Corruption on a project may lead to the injury or death of a government official.  This may occur, for example, where an official who reports corruption or his suspicions of corruption, or is a witness to corruption, or who tries to blackmail a corrupt party, is injured or killed.

 

Loss and damage to the public:  The public may suffer loss and damage as a result of corruption in a particular infrastructure project, and as a result of widespread corruption in the infrastructure sector generally.  Such corruption may result in:

  • Inadequate infrastructure – i.e. lack of proper roads, railways, schools, hospitals, power and water supplies, and housing.

  • Dangerous infrastructure – for example, where bridges are not properly supported, or where housing and shops are built without proper steel reinforcement or fire safety measures.

  • Displacement of people – for example, where people are moved to make way for large scale projects such as dams and mines and are not properly re-housed or compensated.

  • Damage to the environment – for example, where farming and water supplies are damaged.

  • Reduced spending in infrastructure due to loss of confidence in the sector so that budget decision-makers are reluctant to commit funds to the sector due to lack of confidence that the money will be properly spent.

  • Reduced public expenditure generally because of depleted public funds where funds have been stolen or wasted through corruption

  • Reduced foreign investment due to loss of confidence in the country as a result of the perceived prevalence of corruption.

As a result, the members of public affected may suffer the following categories of loss and damage:

  • Loss of quality of life:  Lack of proper infrastructure will result in inadequate transport, education, health care, water, power, housing, hotels and workplaces.  The cost of corruption in this case may be considerable (and unquantifiable) loss of quality of life.

  • Loss of earnings:  Lack of education, transport, health care, water, power, housing, hotels and workplaces will result in a less qualified work force, ill-health, reduced tourism, and difficulties in producing and transporting agricultural produce, raw materials and manufactured goods.  These in turn will result in reduced employment and trade.  The cost of corruption in this case will be loss of earnings for individuals which will in poorer countries perpetuate the poverty cycle.

  • Increased taxation:  Where public funds have been depleted through corruption, taxation may be increased to make up the shortfall.  The cost of corruption in this case is the increase in taxation.  Any resulting benefit to the public which may result from increased expenditure on public services will need to be off-set against the loss caused by increased taxation.

  • Injury and death:  Poor infrastructure may mean that there are inadequate health facilities and/or that there is poor access to these facilities and/or that due to loss of earnings and increased taxation people are unable to afford proper medical care.  Dangerous infrastructure, such as defective roads, bridges and railways, may results in accidents where people are injured or killed.

  • Contributing to endemic corruption:  Corruption which is and is perceived to be widespread in the infrastructure sector may contribute to creating further corruption in a particular country – which will then magnify the other categories of loss and damage caused to the public described above.

 

Section 2:


Quantifying the cost of

corruption in infrastructure




Impossibility of obtaining accurate figures

It is impossible to give any accurate figures of the cost of corruption in the infrastructure sector on a project, or national or international scale.  This is for a number of reasons:

  • Lack of raw data of proven corrupt activities:  In measuring the cost of corruption, one must first identify proven corrupt activities, and then measure the loss and damage which has flowed from those activities.  However, in most cases, the raw data of proven corrupt activities is unlikely to be fully available.  Firstly, corrupt activity is by its nature concealed and so may never be discovered at all.  Secondly, even where it is suspected or rumoured, it must then be proven if it is to constitute reliable data.  However, in many cases, suspicions of corruption are not investigated or prosecuted, and even where prosecutions are brought these may not result in a conviction.  For example, in a particular project the following corrupt activities may have occurred:

    • Theft of 20% of project funds
    • Corrupt financing terms which will result in too high interest rates
    • Over-design of the design in four of the major project contracts
    • Bribes paid in tendering of six major contracts and 40 sub-contracts
    • Price-fixing in tendering of three major contracts
    • 300 fraudulent claims submitted in major contracts and sub-contracts
    • 50 facilitation payments made at police road checks and in order to obtain work and import permits
    • Defective works and materials supplied and corruptly approved in 10 sub-contracts which have fed through to the major contracts
    • Fraudulent levying of liquidated damages on two contractors.

In order to establish reliable data on which to base a quantification of the cost of corruption in this project, each of the above corrupt activities would have to be identified, investigated, prosecuted and proven.  This process would not only be very difficult, but also be extremely costly.

  • Difficulty in identifying the type of loss and damage that flows from the proven corrupt activities:  From those proven corrupt activities that are identified, it may be difficult to identify the type of loss and damage has flowed from them.  Taking the example in the previous paragraph, one would need to consider each proven corrupt activity and then try to identify each stakeholder that has suffered loss and damage as a result of that activity and the type of loss and damage which has been suffered (e.g. additional financing costs, cost of bribe included in contract price, rectification costs etc.). 

  • Difficulty in quantifying the loss and damage which has been identified:  For each proven type of loss, it would then be necessary to try to calculate the quantum of loss.  This is probably impossible.  For example, how much has a tenderer lost who failed to win a contract because a competitor paid a bribe?  How much has a project owner lost because a contractor paid a bribe to win the project (e.g. was it just the cost of the bribe, or did the contractor increase its tender price, and if so, by how much?).  How much has the public lost due to an over-designed power station (should the electricity tariff have been 5% lower? 10% lower?).  How much has a community lost in financial terms when a road is damaged during a flood, as a result of its corruptly defective construction?

The above difficulties are explained at project level.  To calculate these losses on a national or international scale would require accurate data on all projects.  Consequently, any attempt to quantify the cost of corruption should acknowledge that the result will at best be a very rough estimate, and will most likely be merely a guess. 

 

Estimating the cost of corruption in infrastructure

In view of the difficulty in calculating the actual loss to corruption, attempts have been made to estimate this loss. A common form of estimate uses the average percentage of project value that is assumed to be required to be paid as a bribe in a particular country in order to win a main contract. For example, it could be said that in Country X, bribes are normally in the region of 5% of the main contract price for public sector projects. This estimate is then used to provide an estimated global figure of the loss to corruption by taking a similar percentage of total infrastructure expenditure worldwide.

However, even as an estimate, this is not necessarily representative of the full cost of corruption on a particular project. It may be only a small part of the equation. In particular, it takes no account of the bribes that may have been factored into contract prices further down the contractual chain in order to win sub-contracts and supply contracts. The cost of these bribes is normally included in the contract prices all the way up the contractual chain. As a result, a bribe of 5% paid to win a main contract will be calculated on a build up of sub-contract prices which in themselves may already include bribes. The overall loss to bribery on award of all the project contracts could therefore be far higher than the 5% paid at main contract level. This can be demonstrated in the following example where the ostensible bribe on the main contract was only 5%. However, the overall loss to the public purse due to bribery was $16 million, this being 16% of what the main contract price should have been.

Contractual chain Contract price with bribe (i.e. other sub-contract price + own price + bribe) ($) Contract price without bribe ($)
     
Sub-sub-sub-sub-contractor
0m + 20m + 5% bribe = 21m
20m
Sub-sub-sub-contractor 21m + 20m + 5% bribe = 43.05m 40m
Sub-sub-contractor 43.05 + 20m + 5% bribe = 66.2m 60m
Sub-contractor 66.2m + 20m + 5% bribe = 90.5m 80m
Main contractor 90.5 + 20m + 5% bribe = 116m 100m

 

The above example assumes that each sub-contractor is obliged to pay a bribe of 5%, and has included the cost of the bribe in its own contract price. This then means that the project owner/taxpayer (in the event of public sector projects) or the project owner (in the case of private sector projects) eventually bears all those bribery costs. However, to the extent that this does not happen, then the relevant contractor or sub-contractor will itself suffer the cost of the bribe.

The above method of estimate also does not cater for other types of corruption that may take place during the project (e.g. corrupt over-design, corruptly defective work, bribes paid to obtain certificates and permits etc.).

The "Effect of Corruption on Project Costs" (below) provides an example of how different types of corruption throughout the cycle of an infrastructure project result in a very large cumulative increase in project cost.



Section3:

Example of the effect
of corruption


on project costs


Corruption can occur all the way down the contractual chain. A major infrastructure project may have thousands of contractual links, between the main contractor, sub-contractors, sub-sub-contractors and suppliers. At the top of the chain, the main contractor may pay US$30 million as a bribe to the government representative in return for the award of a major infrastructure project. At the bottom of the chain, a sub-sub-contractor or supplier may make a payment of US$500 to the procurement manager of a company in exchange for a minor sub-contract or supply contract. Fraud (such as false or inflated claims) can also have an enormous impact on the overall contract price. It can occur at every contractual link. The cost of the bribes and false claims will often form part of the final contract price, and have a cumulative effect. A bribe or false claim at the bottom end of the chain may be passed all the way up the chain, with an overhead cost added at every level, magnifying the cost of the initial bribe or fraudulent act. While the costs and effects would vary tremendously from project to project, the following hypothetical scenario illustrates the cumulative effect of bribery and fraud on a infrastructure project.

Assumed facts

Assume that a power station would cost $100 million if properly engineered, if awarded after a genuine arms-length open-market tender, and if managed in an environment free from bribery and fraud. The following example analyses what could happen to the $100 million price if the environment was not free from bribery and fraud. The calculations and methodology are deliberately simplistic.

  • A utility in a developing country requires a power station, and calls for international tenders to build the power station.
  • The power station which should cost $100 million is over-designed and over-specified by 20% so as to maximise the opportunities for bribery amongst the government ministers and utility staff. Additional cost: $20 million. Power station cost now $120 million.
  • The contract calls for a 10% retention. The contractor assumes that it will never be paid the retention, as it is aware that the utility will probably create false claims against the contractor to set off against the retention. The contractor therefore adds the value of the retention into the contract price twice. Additional cost: $12 million. Power station cost now $132 million.
  • A bribe of 10% of the contract price is required. The contractor includes the cost of the bribe in the contract price. Additional cost: $13.2 million. Power station cost now $145.2 million.
  • The power station cost is to be covered by an export credit guarantee in the form of a buyer credit. 15% of the project cost will be paid by the utility in cash direct to the contractor. 85% of the project cost ($123.4 million) will be financed by a loan from an international bank secured by the export credit. The utility is based in a high risk country for which the export credit agency charges a premium of 8%. The premium on the uninflated cost of $100 million is already included as part of the $100 million cost. The additional unnecessary cost of the power station is $45.2 million. The additional premium on this amount is $3.6 million (8% x $45.2 million). Power station cost now $148.8 million.
  • The infrastructure period is 3 years. The loan on 85% of the project cost charges interest at 6% per annum over 15 years. Interest during the 3 year construction period is to be capitalised. The utility would in any event be paying interest during construction on the uninflated cost of $100 million. The additional unnecessary capitalised interest during construction is $8.8 million (8% x $48.8 million x 3 years). Power station cost now $157.6 million.
  • The project is completed late, and there are some defects and performance deficiencies in the power station. The contractor and the utility blame each other. The contractor makes claims against the utility for variations and loss and expense. The utility has no intention of paying the contractor’s claims. It also wishes to keep the retention of 10%. It therefore counterclaims against the contractor for liquidated damages, defective work and performance deficiencies. The counterclaim of the utility is equivalent to 10% of the contract price plus the value of the contractor’s claims. The contractor increases its claim to a figure which matches the utility’s claim. The claims and counterclaims therefore effectively neutralise each other. A large proportion of both the contractor’s claims and the utility’s counterclaims are false or exaggerated. After each incurring legal and expert fees of $0.4 million, the contractor and the utility settle on a walk away basis. The contractor is compelled to absorb costs which it should have been able to recover from the utility had the utility not falsified counterclaims. Power station cost to the utility now $158 million.
  • The capital cost of the power station is therefore, at the date of completion of the project, $58 million higher than it should have been. The cost will further increase during the lifetime of the 15 year loan, as interest of 6% per annum will be paid by the utility on the additional unnecessary cost of $58 million. This results in the utility paying additional unnecessary finance charges of $3.5 million per annum.
  • As a result, the utility has a capital overspend of $58 million which needs to be repaid, and an additional annual finance charge of $3.5 million.
  • The consumers who use the electricity produced by the power station would not be able to afford the electricity if the true cost of producing the electricity were taken into account. The utility therefore charges a subsidised amount for the power, and its income as a result is too low for the utility to be able to repay the capital and pay the interest on the loan for the power station. The utility defaults on the loan.
  • The power station breaks down. Because of the default on the loan, the utility is unable to borrow further sums to purchase spare parts. The contractor is aware of the utility’s financial difficulties, and therefore refuses to supply spare parts and to repair the power station unless it is paid in advance in cash. The utility cannot do so. The power station is not repaired. The consumers receive insufficient electricity.
  • The bank is paid its annual interest under the export credit guarantee.
  • Eventually, part of the outstanding capital and interest in relation to the loan for the power station is written off as a result of an international debt relief package. The bank is re-paid its capital under the export credit guarantee.

Result of above assumed facts

  • The consumers in the developing country do not receive a continuous supply of electricity due to the late completion, breakdown and non-repair of the power station. This damages industry in the developing country.
  • Aid to the developing country is cut back due to the loan default and rumoured corruption in relation to the project.
  • The $58 million overspend means that this sum is not available for use on other projects.
  • Part of the ultimate cost of the bribe and project overspend is paid by taxpayers in the developing country, who cannot afford such a burden. The balance is paid by taxpayers in the developed country owing to the debt write-off.
  • No further orders for major capital projects are placed by the developing country due to lack of aid. The consumers in the developing country lose the opportunity to improve their lives. Contractors in the developed world lose potential business.
  • In the short term, the contractor and the bank gain, as the contractor is paid the contract price, and the bank is paid the capital and interest on the loan. However, in the long-term, they lose potential business in the country due to lack of further development.
  • The contractor and its relevant employees face the long-term risk that the bribe will be discovered, and that they will be prosecuted for bribery. The bank and export credit agency and their employees face the risk of being prosecuted for aiding and abetting if they knew of the circumstances of the bribe, or were wilfully blind.
  • Ultimately, only the recipients of the bribe gain. They may move country to avoid prosecution. The bribe money is normally retained in offshore bank accounts for the use of the recipients of the bribe and their families.



Section 4:


The relevance of the cost of corruption


Measuring the cost of corruption is often considered to be a necessary part of determining how to combat corruption. The view is that a suitably significant cost must be shown in order to justify the cost of implementing anti-corruption measures and in order to indicate where the focus of anti-corruption measures should be. However, as shown above, it is not possible accurately to estimate the cost of corruption, nor is it possible to identify where the greatest corruption may take place in a project. Attempts to do so may result in a distorted picture of the degree of corruption in any particular project phase with a consequent mistaken focus of anti-corruption measures.

The decision to combat corruption should be made on the following assumptions:

  • No individual or organisation is immune to corruption;
  • Corruption can occur in developing or developed countries;
  • The incidence of corruption is a function of the degree of anti-corruption measures in place;
  • The fewer anti-corruption measures in place, the greater the risk of corruption;
  • In any infrastructure project:

    • there is a significant likelihood of corruption;
    • corruption can occur in any phase;
    • the higher the value of the project, the higher the likely loss to corruption.

Appropriate preventive measures should be implemented on the basis of the above assumptions and not on the basis of any (most likely inaccurate) estimate of the costs of corruption in any particular country, sector, type of project or project phase.

Anti-corruption measures should therefore be implemented as part of the routine management controls on a project.


.

Other resources

Several organisations provide guidance and information on the above issues. These organisations are listed below in alphabetical order.   If the following details are inaccurate or incomplete, or if you are willing for your organisation to be listed below, please send details to GIACC.   Only services and tools which are available free of charge will be listed.

 

The Chartered Institute of Building

 

Transparency International

 

U4 Anti-Corruption Resource Centre

 

World Bank

 

Most recent update on 30th January 2013

Page first published on 1st May 2008



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