Eastern Bloc Corruption

After my recent visit to Ukraine for a few days, it gave me a chance to visit the country with a bit of a fresh look. After the mountains of cases that you tend to read at b-school, it makes you more inquisitive and questioning of what goes on around you at least from an economic and financial standpoint.

Corruption is all-pervasive in the country, with shit flowing down from the top, ie from the president, right down to the lowly cops on the beat (pun intended). The good people at transparency international (www.transparency.org) compile a widely disseminated corruptions perceptions index and their respective rankings, see Gazprom Valuation and some mention here: Hermitage Captial Management although I was specifically looking for a mention from an article on the economist that mentions a study describing how much of a drag that corruption has a drag on market capital valuations on the Russian stock exchanges (think it was around a 20% discount).

Corruption is a monster that encroaches on many parts of peoples' lives. The part that lately interests me is the effect on capex recovery times and retail prices. The logic goes something like this:

1. An entrepreneur wants to set up shop in an economy heavily subjected to corruption
2. Planning and permissions are subjected to bribery fees, costs and charges to "expedite" the permit process [PRICE DISTORTION 1]
3. Retail establishment is set up
4. a) Depending on the depth of corruption, the business may either be extorted additional funds by local police, mafia (with some connection to the state) or similar government additional agency during its time of operation. [PRICE DISTORTION 2]
    b) an alternative to (a) above is where the property is completely appropriated by one of the agencies mentioned above, either for compliance failure or some similar excuse

Price distortion 1 is probably the most common and thus the most predictable; I've heard estimates of upwards of 20% of the capital cost of a venture may need to go do additional "facilitation costs". However it is the second price distortion that I think is causing an impact on retail prices. Certainly prices in the east aren't reflective of the low price of labour in that country. Goods in Kiev were similarly or higher priced than their counterparts in the West. And import duties and transport costs just don't pass as a good enough excuse considering the size of the country's markets and their proximity to Europe.  And obviously locally produced goods with local input goods should be fairly priced.

The second price distortion I believe causes higher retail costs due to the owner needing to recover his capital investment as soon as possible before his business is closed down (unlikely), appropriated (more likely) or continuance-of-business fees are extorted (most likely). The driving factor of the retail price impact is how fast capital recovery must happen. For a bar, its life cycle is typically only a few years due to the nature of its fickle clientele. Thus prices need to be much higher than a average quality restaurant, which can spread the cost of bribes over a lower period. It is also likely to attract less bureaucratic attention than a bar or a club. Those restaurants that are in a building, say a hotel, would enjoy some implicit protection from the owner of the hotel and thus would be under less price pressure.

Time to do a bit of looking around to see what studies have been done....