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Corruption Challenges Infrastructure Growth

Development organizations battle endemic bribe-paying in $3 trillion global construction industry

HARD HAT BREAK A worker takes a rest in a concrete tube in Phnom Penh, Cambodia. Public works projects in Asia are magnets for corruption, say experts.
Photo by AFP

In the People’s Republic of China (PRC), a court upholds a former Beijing vice mayor’s suspended death sentence for corruption in connection with construction projects for the 2008 Olympic Games.

In Japan, three executives are convicted and their consulting company fined after they admit bribing a senior Vietnamese official to secure contracts for road construction contracts funded by Japanese aid money.

In the Philippines, the World Bank debars eight firms and one individual after a lengthy investigation finds they colluded with each other and government officials to rig bids for major bank-financed road projects.

Across Asia, governments, multilateral institutions, private companies, and advocacy groups have been grappling with corruption, an age-old problem that has taken on epidemic proportions in recent years amid the region’s world-beating economic growth and rapid development.

All told, the World Bank Institute reports, more than $1 trillion is paid in bribes each year—equivalent to about 5% of global gross domestic product (GDP)—with the burden falling most heavily on people living in extreme poverty.

The problem is especially acute in the construction sector, a $3 trillion industry worldwide that, because of the size and complexity of projects, extensive approval processes, and multiple layers of contractors, affords the greatest opportunities for corruption. The London-based Construction Sector Transparency Initiative estimates that direct and indirect losses from corruption in the industry amount to 15%–30% per year.

Transparency International (TI), a nongovernment anticorruption organization based in Berlin, also ranks public works/construction as the most corrupt sector internationally, saying its projects are the most likely to involve the bribing of public officials or political contributions aimed at influencing policies, laws, and regulations.

“For corrupt politicians and officials, construction projects are the perfect vehicle to dispense patronage and amass illegal private wealth,” says Chandrashekhar Krishnan, executive director of TI’s national chapter in the United Kingdom.

“The costs are not only financial,” he adds. “Lives are lost when corruptly constructed houses and schools collapse in earthquakes; unnecessary infrastructure projects are built, diverting scarce resources from other pressing needs such as health, water, and education; and shoddy infrastructure is produced and the environment is destroyed because regulations and standards are circumvented.”

In TI’s latest edition of the Bribe Payers Index, a rating of the tendency of firms from 22 international and regional exporting countries to pay bribes to win contracts abroad, Belgian and Canadian firms were judged the least likely to make illegal payoffs. Ranked as most likely to pay bribes were firms from Russia, the PRC, Mexico, and India, in that order.

But while graft remains rampant, threatening to undermine civil society in some countries, anticorruption activists see signs of hope. They point to increased public awareness and resentment of corruption, crackdowns by governments and international organizations, recognition by the private sector of its damaging effects, and a growing array of tools and methods designed to detect and prevent it.

In combating corruption, the risk of public exposure—as in the aforementioned cases in the PRC, Japan, and the Philippines—offers a potentially strong deterrent, especially when accompanied by sanctions.

For multilateral institutions, the most powerful weapon is often “debarment,” or blacklisting, of a company found to be involved in corruption. In January, the World Bank made public the names of four PRC companies, three Philippine firms, and the Filipino owner of one of the firms after investigators found evidence of bid-rigging. Joining a firm from the Republic of Korea that was blacklisted earlier, they received debarments of varying terms, two of them permanent, and the bank announced that it had stopped about $33 million from being awarded.

A month later, the Asian Development Bank (ADB) confirmed that it had blacklisted 41 companies and 38 individuals in 2008 for corruption, bringing to 552 the total number of banned firms and individuals since 1998. The offenses ranged from fairly minor fraud to bidding collusion on a $10 million road project. Although ADB does not publicly release names in such cases, it said it shares the information with international organizations.

In the construction industry, corruption can seep into projects in myriad ways in various phases, ranging from project identification, planning, or financing to design, tender, execution, operation, or maintenance, according to the Global Infrastructure Anti-Corruption Center, an international nonprofit group based in England. It can involve the government, project owner, funding parties, consultants, contractors, subcontractors, suppliers, joint venture partners, or agents, and can take many forms, including bribery, extortion, fraud, collusion, embezzlement, influence peddling, and money laundering. It is usually concealed, with those aware of the corruption either complicit in it or reluctant to report it.

Bribes can be paid directly to win a contract, for example, but the more common method is to use an intermediary such as an agent, TI says in a report on preventing corruption in construction projects. The contractor hires an agent with high-level contacts and pays a fee or a percentage of the contract price, a large chunk of which the agent then passes on to the representative of the project owner or government official responsible for awarding the contract. The bribes—often deposited in offshore bank accounts may be hidden in formal agreements that exaggerate the scope of the agent’s work.

Because agents are so commonly used and often do legitimate work—the arrangement can be difficult to detect.

Joint-venture partners, subsidiaries, and subcontractors also offer vehicles for bribes, especially when they are based in countries with weak investigative or regulatory capabilities. In such cases, the agency agreement can be executed in, and the bribe paid from, the country least likely to discover it.

However, the misuse of the agency agreement “is not an insurmountable problem,” says TI’s Mr. Krishnan. “It can be addressed. And it is entirely possible to work through honest agents.”

STANDING UP A high school student displays a sticker during an anticorruption demonstration in Jakarta, Indonesia. The country has written integrity pacts into legislation.
Photo by AFP

In promoting “clean construction” practices, “there are a number of tools available to people in the industry,” Mr. Krishnan says. Among them are “construction integrity pacts,” which he says “can reduce corruption risks and therefore save public resources.”

Developed by TI in the 1990s, the pacts have been used in various forms in at least 14 countries. Three model pacts tailored for construction projects, both public and private, include an agreement among companies in the same sector to refrain from bribery and other corrupt practices when they compete against each other for contracts anywhere in the world; an accord between the project owner, designer, and all bidders to act with integrity in the pre-qualification and tendering process; and a pact in which the owner, certifier, and selected contractor pledge to resist corruption in the execution of a specific project.

In addition to the pledges, the pacts include measures “to ensure that the agreements are policed and enforced,” TI says.

According to Mr. Krishnan, the pacts work because contractors, project owners, and funding entities all have an interest in preventing bribery.

“Many companies are beginning to see that there’s a strong business case against corruption,” he says. “I think companies are seeing now that you can really suffer a lot if you get caught out in a major corruption scandal.”

PricewaterhouseCoopers, one of the world’s largest professional services firms, agrees that companies need “an anticorruption strategy that goes beyond avoiding potential enforcement penalties,” not least because it is “part of good governance and adds to the value of the corporate brand.”

PricewaterhouseCoopers reported last year that 63% of senior executives in a global online survey said they had experienced some sort of actual or attempted corruption, and 42% said their competitors pay bribes. Nearly 45% said corruption had dissuaded them from entering a certain market or pursuing an opportunity and 39% said their company had lost a bid because of corrupt officials.

However, while nearly 80% of the executives said their company had a program to detect and prevent corruption, only 22% were confident of its effectiveness, the survey showed.

Nikola Sandoval, TI’s senior program coordinator for Southeast Asia and the Pacific, sees similar mixed results for anticorruption efforts in Asia. “In some areas there’s quite a lot of progress that’s being made,” she says. “But there’s still a long way to go.”

She cites Pakistan and Indonesia as countries where integrity pacts have been “quite successful.”

In Indonesia, “it’s been written into legislation that on any contract above a certain threshold, an integrity pact needs to be implemented as part of the process,” she says. “This helps to get some monitoring. It gets a commitment from everyone in the contracting process that they will not engage in any corrupt activities, and it sets out what the sanctions would be.”

The pacts have “worked very well” since they were adopted in Indonesia about five years ago, Ms. Sandoval says, with one notable shortcoming: a lack of civil society monitoring.

A more recent addition to the anticorruption toolkit is the Project Anti-Corruption System (PACS), which TI issued in 2007 to fight bribery and fraud in the construction sector. It sets out anticorruption standards and templates on independent monitoring, due diligence, contractual commitments, procurement requirements, government obligations, corporate programs, and rules for individuals, training, transparency, reporting, and enforcement. The system is now being developed and promoted by the Global Infrastructure Anti-Corruption Center in alliance with TI, Mr. Krishnan says.

Among other things, PACS standards call for an independent assessor to monitor the project for corruption; public disclosure of project information; tender-stage exchanges of details among the project owner and each bidder on shareholders, agents, joint venture partners and other “corruption risks”; financial audits; and civil and criminal enforcement mechanisms.

PACS measures can be required for projects by government regulatory authorities, public or private owners, or project funding parties, the system’s promoters say. Funding organizations, for example, can make the measures a condition for providing financing.

Multilateral institutions and private companies have “reacted positively” to PACS, Mr. Krishnan says, but adoption of the system is still in its early stages.

Also in the works is a pilot program conducted by the Construction Sector Transparency Initiative (CoST) in seven countries, including the Philippines and Viet Nam. The program is intended to promote accountability in publicly financed construction projects, and the Philippines has appointed a full-time “multistakeholder group coordinator” for the pilot.

But a recent CoST progress report cited a number of obstacles. Key projects to be monitored “are put on hold or canceled late in the pilot phase,” volunteers hesitate to confirm findings “for fear of reprisal,” and transparency groups “show little or superficial interest to collaborate” with CoST, the report says.

“We shouldn’t underestimate the challenges,” Mr. Krishnan says. “But I think if you look at the trends… there are reasons to be optimistic that you can do something about corruption in what is a very difficult sector. I don’t think that would have been the case about 10 or 15 years ago.” •