Communication network MSc Innovation Strategy Entrepreneurship

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Corruption and Morality in International Business

Federico Albini

Abstract

The purpose of this paper is to focus on the relationship between the economic side of corruption and the moral aspects of it. It can be argued that corruption is always morally wrong as it goes against morally accepted principles and laws. However, many economists have reasoned that corruption might have beneficial impacts on the economy of a country as a whole. Moreover, on a business perspective corruption is considered a usual practice in many countries. My opinion is that corruption becomes morally corrupt in the moment in which it will be acknowledged by society that the negative effects of corruption exceed its benefits.

The paper is divided in three parts. The first part consists in a brief introduction to the concept of corruption, which provides definitions and important classifications. The second part is a review of some of the economic research conducted providing evidence of the effect of corruption on development. The third part focuses on trying to draw a line between the cases in which corruption is already morally wrong and the cases in which further time and efforts are needed to establish corruption as an immoral practice.

I.              Introduction and definitions

Government corruption has been defined as “the sale by government officials of government property for personal gain” (Sheleifer and Vishny, 1993).

Corruption can take different forms depending on the hierarchical level at which it is occurring: from licenses and other documents to infrastructure projects and allocations of resources to industries (Rose-Ackerman, 1997). We call petty corruption the corruption resulting from the interaction between private actors and non-elected officials. Grand corruption is the result of the interaction between private actors and elected officials (Elliott, 1997).

Another important distinction for the purpose of our discussion, is introduced by Sheleifer and Vishny (1993) when they discern between corruption with theft and corruption without theft. Corruption with theft occurs when the government agent doesn’t declare the deal to the government. In this case, the price paid by the private actor might be even lower than the regular (legal) price for the transaction. Corruption without theft occurs when the private actors must pay an additional bribe to the government official over the regular (legal) price of the transaction.  An example will help to clarify the concept. Let’s imagine the case in which a private actor is fined for having parked his/her car in a no parking area. In the instance of corruption with theft, the policeman might ask for a bribe smaller than the fine and agree to nullify the fine. In the instance of corruption without theft, the policeman might threaten to block the car for one month and ask the payment of an additional bribe over the regular price of the fine.

Furthermore, certain sectors are more likely to experience corruption practices than others, this derives from the composition of bureaucracies in different government activities has, as we will see, an important negative effect on development.

I.              Macroeconomic research on corruption: social costs and benefits

Economists have argued for a long time that corruption might be beneficial for economic development. Two main arguments are used in favor of corruption. The first argument states that corruption is a way of avoiding bureaucratic delays, which increases efficiency and ultimately the enables a faster country’s development (Leff, 1964). The second argument is that corruption increases the productivity of corrupted government officials because the bribes act as an incentive therefore creating positive outcomes on the economy as a whole (Huntington, 1968).

In more recent times, however, economists have started to point out the negative relationship between corruption and economic development. Mauro (1995) has presented the first statistical analysis of this correlation and found a strong negative association between corruption and economic growth.

Many authors have given explanations for the effects involved and leading to these results. Sheleifer and Vishny (1993) have pointed, in particular, to the problem of secrecy. In many aspects, the authors argue, corruption can be thought as the twin activity of taxation. The main difference between the two is that taxation is a legal and established process while corruption requires secrecy. Secrecy costs can be divided in three main categories. The first category of cost is the one generating from the reallocation of resources to the sectors in which opportunities for corruption are higher. This process is claimed to divert the attention from strategic sectors for development, such as education and healthcare, towards activities such as infrastructure projects and military spending where possibility for corruption are much higher. The second category of secrecy costs is constituted by the reallocation of resources, perpetuated by government officials, such as time and political activity, in creating bureaucratic barriers necessary to allow rent seeking activities, which ultimately disperse the gains accumulated from the bribes. The third category of cost associated with secrecy is the hindering of innovation generated by the efforts of governments in maintaining the status quo through the protection of monopolies and the preservation of an elite class ultimately responsible for political and industrial decisions in the country.

Another set of costs associated with corruption is related to the strength of the control of the central government. Sheleifer and Vishny (1993) have showed that the organizational structure of corruption networks shares many similarities with the different kinds of industrial organization configurations. In this sense, the corruption network can act as a monopoly (maximizing profit) if a single person takes all the decisions (e.g. a dictator); it can be a collusive (profit maximizing) oligopoly if the decisions of the different officials on bribes are coordinated. In the last case, when the central government is very weak, and the number of government agencies is fixed, the prospect of imposing bribes can be employed by any government agency and even reiterated by them, thus possibly driving the bribe burden for the company to infinity. For example, if to open a new plant in a foreign country a company was forced to pay bribes to a large number of agencies with no certainty that the payment is a una tantum, the evident result would be for the company to choose another country in which to open its new plant. This outcome obviously severely impacts the country development.   

All the above-mentioned costs  (secrecy and innovation impediments) associated with corruption, have shed a new light on the matter of discussion even on an ethical standpoint. In the next part, I will try to establish why this evidence should be the engine of a generalized movement against corruption in international business.

I.              Corruption and Morality in Business

Until this point, we concentrated on the definition and economic aspect of corruption, covering its benefits and costs to a country growth and development. How does this macro perspective relate to the micro perspective in which the decisions of a business are taken?

My opinion is that when private actors become aware of the cost to society triggered by the compliance with the payment of bribes, they are no longer excused to feed the corruption cycle. If, in the past, these costs to society have been somehow neglected and instead eminent economists argued in favor of corruption, this might well be one of the reasons why so many private actors perceive corruption a rather acceptable practice.

Society should, by this time, already generally recognize as morally unacceptable certain kinds of corruption. In the case of corruption with theft, the interests of the buyer and seller align. Going back to the example of the policeman, the person fined agrees to pay less than legally defined by bribing the policeman. Both agents benefit from this conduct: the person fined pays a smaller amount and the agent receives a sum of money under the table. This kind of corruption is the most immoral, and for this reason also the most difficult to eradicate. Once the person fined has agreed to pay the bribe, he/she has no excuse and becomes an active part in the misconduct, no longer a passive victim of the situation. For this reason, the fined person will have no interest to press charges against the policeman, and this kind of behavior will last.  If we apply the same situation of corruption with theft to companies instead that to individuals, we can easily understand that the competition existing between companies will push all of them to infringe the law.

 

In the light of the new research on the effect of corruption on the development of a country, it has become obvious that corruption can no longer be accepted even when the private actor is a “victim” of the situation. Consider the following example. If company X wants to win the tender to build a highway in country Y the company must pay a bribe of 1 million euros to the ministry of infrastructures of country Y. As we know by now, not only infrastructure spending is easier subject to corruption then other more important sectors to a country development such as health and education, but also, the minister will spend his/her time (the people’s who elected him/her time) trying to set up a system to protect is position and making sure that others can’t appropriate the willingness to pay of the company. To summarize, the company might be the victim of the situation and might be hurt economically by not accepting to pay the bribe and lose the contract, but if it accepts to pay the bribe it becomes an active agent in the scenario, committing the morally unacceptable role of impeding the development of the country.

Once all companies start acting in the same way, going in the same direction against corruption, and weak governments are able to exercise more control and create competition, not collusion, between agencies providing the same services (for example in different geographic areas) corruption will slowly disappear. 

II.            Conclusion

The aim of this paper was to determine whether, in some cases, corruption could be regarded as a morally acceptable practice. As every other moral question, the issue of corruption has to do with the general awareness of its consequences on the stakeholder, in our case on whole societies. Even though many economists have for a long time argued the association of corruption with positive macroeconomic effects, recently more rigorous empirical studies have shown that the corruption’s costs exceed its benefit. In particular, these costs reflect on a strong negative relation between corruption and economic development. From this results, I argued that corruption be regarded as a morally unacceptable practice.  In some extreme case such as that of corruption with theft, corruption is already considered morally wrong while in other cases the problem is to eradicate customary practices that make corruption a relatively morally accepted behavior.

Federico Albini

References

Andrei Shleifer and Robert W. Vishny, Agust 1993, “ Corruption”, Quarterly journal of Economics, pages 599-617

Susan Rose-Ackerman, “The political Economy of Corruption", Corruption and the global Economy, Institute for International Economics, 1997, pages 31-60

Kimberly Elliott, “Corruption as an International Policy Problem: Overview and Recommendations”, in K. Elliot (ed.), Corruption and the global Economy, Institute for International Economics, 1997, pages 175-233

Ibid.

Nathaniel Leff, “Economic development through Bureaucratic Corruption”, 1964, American Behavioral Scientist, pages 8-14

Samuel P. Huntington, Political Order in Changing Societies, (New Haven, CT: Yale University Press, 1968)

Paolo Mauro, August 1995,  “Corruption and Growth”, Quarterly journal of Economics, pages 681- 712

Ibid.

Ibid.

Blu-ray vs HD-DVD

by: Federico Albini, Nick Fountas, Melissa Calvario, Nikolay Dimitriev

The Blu-ray format as dominant design

The definition of the new technology for the next generation video format passed through several stages in a competition between two different standards and companies: Sony and Toshiba, with Blu ray and HD DVD respectively. Sony, which had lost a format battle in the 80’s against JVC, this time is the absolute winner and Blu-ray has established itself as the dominant design in the high definition video.

Both companies managed costumers’ expectations by trying to convince the public that their product is, not only superior to the DVD, but also superior to the rival format.
The economist Hal Varian explains this strategy when he says: “The product that people expect to win will win.”(The New Yorker, 16/10/2006) Consumers know that if they back the loser in a standards war they will be stuck with an obsolete product, so convincing them that your product is a winner is essential.

Although for some time HD-DVD was winning ground in sales, the Blu-ray format was able to make different alliances with other companies to offer a wider range of products such as games, movies, series, and entertainment videos and in the end to win this war.

To empirically show the victory of Blu-ray we can refer to the graph of annual production of discs of the two formats

Source: Julian P. Christ and André P. Slowak “Why Blu-ray vs. HD-DVD is not VHS vs. Betamax: The Co-evolution of Standard-setting Consortia” in University of Hohenheim, Stuttgart-Hohenheim, 2009

As we can see in the graph above, the market ‘tipped’ in January 2008 when Warner Bros decided to exclusively support Blu-ray and, furthermore, when Wal-Mart announced the same decision. Companies promoting HD-DVD were no longer able to compete therefore the production of HD-DVD started plunging until no more HD-DVD were produced.

Figure 1 Rate of  Major Innovation – The Abernathy and Utterback Model

In Figure 1 we can see until January 2008 we were in the fluid phase with a high market uncertainty about the dominant design of high-definition discs: prices of players were very high and consumers were afraid to choose one firm, until the winner appeared in the market. 

In January 2008 Blu-ray officially won the war and from that point we entered the transitional phase. Producers have learnt more about how to meet customer needs and a dominant design has emerged. The emphasis shifted from product to process innovation. To better understand this, the price of the main complementary good, the Blu-ray player, in 10/4/2003 was 3800$ (Maxim Liado, 19/10/2007) and now, after 7 years, the price is 128$ (Jeff Bertolucci 11/6/2209)

We believe we have not seen the specific phase yet because of the existence of DVD, which is much cheaper and also meets the customer needs. Blu-ray discs and players are still relatively expensive compared to DVD discs and player.

Strategies that lead to the Sony’s Victory

Strategies are what really matters in a format war. Even the losers will have to adopt strategies in order to deal with the outcomes of their losses. Winners, of course, are in most cases those that put together and implemented the best portfolio of strategies. It is undeniable that both Sony and Toshiba, with Blu-ray and HD-DVD respectively, were really careful in carrying out the most important strategies for this kind of competition. They both built strong alliances with the producers of the content (movies studios) and with the retailers. They both managed the costumers’ expectation so well, that for a long time, most of the people didn’t want to commit to one particular format. They both made sure to build backward compatible players in order for the costumers to be able to watch the DVD movies they already had in their homes.

In the end, as it normally happens in all situations of uncertainty, what really made the difference were single important events that quickly changed the shape of the situation. Those events relate in particular with the alliances and the peculiar inducement strategy that Sony was able to carry out due to its strong position in the game consoles market. We will concentrate on those.

How Sony achieved the winning alliances with content producers and retailers.

Sony learned from the Betamax fiasco in the 80’s and this time built strong strategic alliances that lead to the victory over HD DVD. In May 2002 Sony created the Blu-Ray Foundation with exceptional members like Hitachi, LG, Panasonic, Pioneer, Philips, Samsung Sharp and Thomson (Sony Press release, 20/5/2002). One year later, Mitsubishi joined the Blu-ray Foundation. Later, Dell, HP and TDK also announced their support for the Blu-ray format. These alliances led to the creation of Blu-ray association with 14 executive members including 20^th century fox. Sony not only made alliances with the potential producers of Blu-ray players but also tried to collaborate with the content producers who would create their complementary products, the movies. Although the Big Six of entertainment factory were divided until the end of 2007, Disney, Columbia and 20^th century fox were already supporting Blu-ray. At this time Warner Bros, the biggest player in this market was producing its movies in both formats. Nevertheless, things started to look bad for Blu-ray when, in 2005, Microsoft and Intel announced their support for HD DVD and when in 2007, Paramount and DreamWorks dropped Sony’s format. Also many more Blu-ray supporters, like LG (7/1/2007) and HP (16/12/2005) announced that they would use both formats in their products.

However, Blu-ray discs sales were going well since the beginning of 2007. This is probably the factor that determined the tipping point and the emerging of Blu-ray as the dominant design in the industry. On 4/1/2008 Warner Bros announced his exclusive support to Blu-ray and just one month later the largest US retailers Wal-Mart and Best-buy decided to sell only Blu-ray discs (11 & 15/2/2007). From that moment the market locked in the Blu-ray format.

Source: Nielsen Videoscan

The peculiar inducement strategy of Sony

Another killer strategy by Sony was to give to its game console, the PlayStation 3, the capability of playing Blu-ray discs. This strategy was designed to take advantage of the consumer base constituted by the video gamers, which partly overlaps with the consumers attracted by new technologies like Blu-ray.

In response to this move by Sony, Microsoft allied to Toshiba in support of the HD-DVD format and decided to offer an external HD-DVD player for its console, the Xbox 360.

But Sony’s strategy to have the player built in proved more successful and accounted for a big part of the company final victory for the format. In the period of eight months following the launch, Sony sold 6,2 millions PlayStation 3 while Microsoft only sold 155,000 external HD-DVD players for the Xbox 360.

Sony’s approach can be seen as an inducement strategy because it consisted in an implicit discount, disguised as a free or very low price extra feature. In fact, not only the price for an Xbox 360 with and external HD-DVD drive was higher than that of the PlayStation 3 (with the built in drive) but also the PlayStation 3 itself was a newer console with better technology.

Moreover these extra costs were also incremented by the transaction costs, in particular the time and efforts needed for the purchase of the HD-DVD drive separately.

A multiple dimensions of value analysis

According to the multiple dimensions of value framework, the competition between Blu-ray and DVD, the old standard format, shows us that DVD has still the edge in value for the costumers due especially to its larger installed base. The DVD format, which is certainly in the specific phase, has reached the maturity that leads to a large availability of complementary goods and to achieve dominant preference within the consumers.

In the diagram below we analyze, following the multiple dimension of value framework, the Blu-ray and DVD formats.

                  

            

                            Blu-ray                                          DVD

According to higher capacity of storage, upgrades in the graphics quality, compatibility with different devices and products, the technology used in the Blu-ray format constitutes an improvement compared to the technology used by DVD. The installed base and complementary goods are in the Achilles’ tendon of Blu-ray. The DVD is stronger because of its maturity in the market. There are now more than 90000 movie titles in DVD while there are about 1000 Blu-ray titles. Where Blu-ray really falls behind is in its installed base, even though Sony tried to expand it with its successful PlayStation 3 move. The gap in prices is still high and moreover consumers may be reluctant in changing to the new format and the complementary goods involved, such as the new HD television, and the Blu-ray players.

The value of Blu-ray could quickly increase under the effect of the self-reinforcing cycle. The increase in the installed base would lead to the consequent rise in availability of complementary goods such as content (movies, games) and Blu-ray players.

The bad news for Blu-ray is the expanding streaming industry; with Apple TV, Hulu, Netflix and many other entrants maybe Blu-ray has to fight a different battle this time.

                     

Source: CNET comparison Blu-ray and DVD

 

 

 

 

Source: Home media magazine