GROWTH AND CORRUPTION
Introduction
• Malfunctioning government institutions as severe
obstacles to investment, entreprenuership and
innovasion
– Inefficient judicial system
– Low security of property right
– Cumbursom and dishonest bureaucracies
• Debate on the impact of Corruption on Growth
– Positive impact on growth
– Negative impact on growth
Introduction (cont’d)
• Although most economists agree that efficient
government institutions foster economic growth not
much is know about the magnitude
• The paper tries to identify the channels through which
corruption and other institutional factors affect
economic growth and the magnitude of the effect
• In order to fix the problem of endogeniety the index of
ethnolinguistic fractionalization is used as an
instrument for the institutional factors
• The paper found that corruption lowers investment
and growth
Data
• The BI Indices of Corruption and Institutional Efficiency
– Data gathered from BI correspondents and analysts based
in each country
– Nine selected indices: insitutional change, social change,
oppostion takeover, stability of labor, relationship with
neighbors,terrorism, judiciary system, red tape and
corruption
– All BI indices are postively and strognly correlated
• E.g., corruption vs red tape
– Bureaucratic efficiency proxied by the average of judiciary
system, red tape and corruption indices
– Political stability proxied by the average of the other six
indices
Data (cont’d)
– All the nine indices can be aggregated to give an
average index of institutional efficiency
– Richer countries and fast growing countries tend to
have better institutions than poorer countries. But,
there are exceptions: Thailand (most corrupt but good
economic performance) and Korea (fast growth but
relatively inefficient institutions)
– Strong association between bureaucratic efficiency
and political stability: there is strond correlation
between two varibles and most countries lie in the
same quintile based on the two indices (this does not
apply to all countries however)
Data (cont’d)
– The fact that the indices reflect the subjective opinions of
BI’s correspondents has both advantages and
disadvantages:
• the addvatage is related with the political stability variables.
• One disadvantage is the problem of unclear scale of measurement.
• An even more serious disadvantage that the correspondents
evaluation of the difference indices might have been influenced by
the economic performance of the country
– In addition to the possible measurement error, economic
perfomance may affect institutional effieciency
– In order to fix the problem of endogeniety arising either
from measruement error or geniunn endogeniety, an index
of ethnolinguistic fractionalization was used as an
instrument
Data (cont’d)
• The Index of Ethnolinguistic Fractionalization (ELF) and
Other Variables
– The raw data from which ELF index was constructed refer to
1960 and the source is Deparment of Geodesy and Cargography
of the State Geology Committee of the USSR 1964
– The criteria for characterizing groups as ethnically separate was
based on historical linguistic origin
– The ELF index can be given as follows:
ELF = 1-
Where ni is the number of people in the ith
group, N is the total population and I is the number of
ethnolinguistic groups in the country.
Data (cont’d)
– Assumed that ELF is is exogenous and unrelated to
economic variables except through its effects on
institutional effeciency; it is a valid instrument
– Negative and significant correlation between institutional
efficiency and ethnolinguistic fractionalization. Ethinic
conflict may lead to political instability. The presence of
many different ethnolinguistic groups worsens corruption
– ELF index is a valid instrument only for institutional
efficiency index
– Varible related with collenial history was also used based
on the data sources of Encyclopedia Britannica and the
World Handbook of Political and Social Indicators
Emperical Estimates
• Corruption and Investment
– Corruption affects investment rate negatively and
significantly both in the OLS and 2SLS estimates using the
simple corruption index
– The magnitude is also considerable: a one SD increase in
the corruption index is associated with an increase in the
investment rate by 2% of GDP
– The slope coeffiecient does not significanlty differ in lowred-tape and high-red-tape sub-samples of countries
– Similar result is observed when the bureaucratic efficiency
index is used instead of the simple corruption index
Empirical Estmates (cont’d)
– Equipment invesment which is more related with
growth is significanlty more closely associated with
bureaucratic efficiency than nonequipment
investment
– Both the simple corruption index and bureacratic
inefficiency are negatively associated with the
investment rate even after controlling for a variety of
other determinants of investment
– The main channel through which bad institutions
affect the growth rate is by lowering the invesment
rate
Empirical Estimates (cont’d)
• Corruption and Growth
– The corruption and the bureaucratic effieciency indices both
significantly affect average per capita GDP growth
– The result is robust to different specification of control variables
– The null hypothesis of no relationship between investment and
corruption can be rejected at a level of significance higher than
the null hypothesis of no relationship between growth and
corruption can
– In the context of an endogenous growth model, bureaucratic
inefficiency could affect growth indireclty through investment or
directly
– Similarly, in neoclassical growth models, corruption could affect
the steady-state level of income
• E.g, through missallocation of production among sectors
Empirical Estimates (cont’d)
– When investment is included as a an independent variable
in the growth regression, the bureacratic efficiency and
corruption indices will either become insignificant or their
slope become smaller
– Investment may also be affected by growth (endogeneity
problem)
– 2SLS was used using the nine BI indices
– There is only weak support for the hypothesis that
corruption reduces growth by leading to inefficient
investment choices
– A considerable portion of the effects of corruption on
growth works through its effects on the total amounts of
investment
Conclusion
• The negative association between corruption and
investment as well as growth is significant in both
a statistical and an economic sense
• The result is robust to different regression
specifications including IV estimation and
inclusion of relevant factors
• Three areas for further research inlcude
– The positive and significant correlation between
indices of bureaucratic efficiency and political stabilty
• Stratagic complementarity may be one explanation
Conclusion (cont’d)
– The behavior of different types of governments
with respect to the compostion of government
expenditure; e.g, corrupt governements may
invest less on education
– The reverse causal link from poverty to bad
institutions; persistent poverty may lead to bad
institutions