Can the Mafia divert the allocation of public transfers?

Guglielmo Barone, Gaia Narciso 05 May 2012

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Organised crime is widely regarded as damaging to economic outcomes – let alone the effects on people’s lives. Yet little is known about the mechanism at work. A recent study by Pinotti (2011) estimates the impact of organised crime on GDP-per-capita in Italy. Pinotti compares Southern Italian regions on the basis of the dynamics and historical roots of different groups involved in organised crime. According to his analysis, organised crime is responsible for a 16% loss in GDP-per-capita over a 30-year period. Bonaccorsi di Patti (2009) shows that crime adversely affects access to credit. Borrowers in high-crime areas are found to pay higher interest rates, pledge more collateral, and resort less to asset-backed loans and more to revolving credit lines.

Building on the emerging literature analysing the economic consequences of organised crime, our recent work (Barone and Narciso 2012) enhances our understanding of organised crime activities by studying whether organised crime diverts public transfers. This issue is especially relevant in the case of public subsidies to businesses, given the pervasive presence of organised crime in everyday socio-economic and political life (Allum and Sieber 2003). Anecdotal evidence suggests that organised crime is estimated to control one in five businesses in Italy (BBC 2000). Similarly, in 1998, the Russian government suggested that the Russian mafia controlled 40% of private business and 60% of state-owned companies (BBC 1998).

We focus on the Sicilian Mafia and measure its presence using an innovative and confidential dataset made available by the Italian government. This provides detailed information on crime at municipality level, by article of the Italian Penal Code, over the period 2004-9. We assume that the Mafia is active in a municipality if at least one Mafia-related crime has been registered in that municipality over the period. Public transfers are measured by aggregating the amount of funds transferred to firms at municipality level. These funds have, for many years, been the main policy instrument for reducing territorial disparities in Italy by offering a subsidy to businesses willing to invest in poorer regions. We find that after controlling for several key determinants of the allocation of these funds, such as the unemployment rate and the sectoral composition of the local economy, municipalities with Mafia-related crimes receive a much larger amount of funds. This result is robust to a number of checks and implies that the Mafia diverted about 35% of the total amount of public transfers in Sicily.

This finding has two different explanations. In the first explanation, the state indirectly opposes the Mafia by boosting employment opportunities through the allocation of funding to firms located in Mafia-ridden areas. According to the second explanation, the state offers investment subsidies for general economic development purposes – only for Mafia-connected firms to intercept part of these transfers and pocket the public subsidies. If the first scenario is valid, then it is reasonable to assume that the state tends to target organised crime with other forms of public spending. We consider public expenditure at municipality level on a set of other items, such as expenditure on schooling (distinguishing among nursery services, primary school and lower-secondary school). We show that the positive relationship between Mafia presence and public transfers is not due to a more generous attitude of the state towards areas with a Mafia presence. If anything, these areas are underfunded in terms of expenditure on education relative to those where the Mafia is absent.

Investigative reports indicate that there are four main ways through which the Mafia may divert public transfers to businesses.

  • First, organised crime may resort to the creation of fictitious firms, existing only on paper and with the sole scope of applying for public funding.
  • Second, the Mafia may corrupt or threaten public officials who supervise the allocation of funding.
  • Third, organised crime may collude with the local public sector in modifying town plans to allow fictitious firms to use allotments originally assigned to other uses.
  • Fourth, the Mafia may exploit its connections to local banks involved in the disbursement of public funds.

Some of these conjectures are testable. We can proxy the number of fictitious firms created by the Mafia with the number of businesses seized by Italian police due to links to organised crime. We assemble a dataset at municipality level using information from the Italian agency that administers the goods and properties seized from organised crime and we present evidence of the link between Mafia and local entrepreneurship. Creating a fictitious firm is just a first step of a more complex system in which Mafia pulls the strings of its connections. According to Rossi (2006), government spending in the Italian South has been widely associated with corruption. The next step in our analysis is to demonstrate the link between the Mafia and corruption in local public administration. We show that the Mafia is positively associated with corruption among public officials. This result provides direct evidence of the negative impact of Mafia presence on the functioning of public administration and of its long arm in the public sector. Our findings show that the positive effect of Mafia on public transfers is very likely to come through fraud and an extensive set of connections. In the words of Beppe Pisanu, president of the anti-Mafia commission of the Italian Parliament, “a new Mafia-related bourgeoisie, made of lawyers, notaries, accountants and entrepreneurs, is the connection between criminal organisations and the economic and political reality” (Financial Times 2010).

This paper addresses a relevant policy question: How can a government prevent that public funding is diverted by organised crime? The results indicate that the design of geographically targeted aid policies, such as European Structural Funds, should be supported by detailed analysis of local crime activities. As far as the presence of crime is stronger in poorer, targeted regions, as is likely to be the case, funding policies should take into account the risk that at least part of the money feeds into organised crime. The results of this study suggest that policies based on monetary incentives should be at least accompanied by actions aimed at combating organised crime.

These findings regard the short-run impact of organised crime on economic outcomes. But we expect there to be a long-run impact as well. The Mafia may have long-run disincentive effects by crowding out talent from entrepreneurship, thereby negatively affecting the economy in the long run. By manipulating the assignment of public funds aimed at poorer areas, organised crime actually undermines growth, investment, and development.

References

Allum, F and R Siebert (2003), Organized Crime and the Challenge to Democracy, Abingdon, Routledge.

Barone, G and G Narciso (2012), “The effect of mafia on public transfers”, IIIS Discussion Paper, No. 398.

BBC (1998), “The rise and rise of the Russian mafia”.

BBC (2000), “Mafia ‘gripping Italian economy”.

Bonaccorsi di Patti, E. (2009), “Weak institutions and credit availability: the impact of crime on bank loans”, Bank of Italy Occasional Papers N. 52.

Financial Times (2010), “Italian police combat waves of fraud”.

Pinotti, P (2011), “The Economic Consequences of Organized Crime: Evidence from Southern Italy”, Mimeo.

Rossi, N (2006), Mediterraneo del Nord. Un’altra idea del Mezzogiorno, Laterza, Bari.

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Topics:  Frontiers of economic research Macroeconomic policy Poverty and income inequality

Tags:  Italy, crime, government spending, mafia, organised crime

Senior Economist at the Regional Economic Research Division of the Bank of Italy

Assistant Professor at Trinity College Dublin

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