The comparative effects of corruption and the second fundamental law of capitalism on Inequality Adnan MS Fakir Azraf Uddin Ahmad K M Masnun Hosain Mostafa Rafid Hossain Ridhim Sadman Gani

Introduction Inequality has seen massive increases- in both the developed & developing world Piketty’s work has brought back the dynamic nature of capitalism back to the foreground in the discussion why inequality is so high For developing countries, the inability to redistribute incomes is however seen as key

Existing Literature Corruption is a deterrant to growth .( Mauro(1995), Aidt(2009), Lash(2004), Corruption has quadratic relationship with inequality. - Li,Xi & Xou (2000). High and low level of corruption lead to low inequality- intermediate level of it leads to high inequality. - Li,Xi & Xou (2000). Corruption is endogenous. Endogeneity by IVs & 2SLS. Ethno-Linguistic Fractionalization (ELF), Colonial history and exposure to democracy are good IVs. -Mauro (1995). r-g is one of the central driving forces behind inequality in the long run

r-g Hypothesis 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒 𝑜𝑓 𝑁𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒=𝑟. 𝐾 𝑌 𝛽= 𝑠 𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒 𝑜𝑓 𝑁𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒=𝑟. 𝑠 𝑔 However, many authors have questioned the theoretical assumptions of the model(constant savings as in Krusell& Smith(2015), the role of taxes Galbraith (2014) & empirical validity(Acemoglu& Robinson(2014))

Objectives To build on and further the existing literature by examining non-linear effects of corruption on inequality using a panel of both developed and developing countries. To contribute to the literature by testing the validity of the second fundamental law of capitalism and how it interacts with increasing levels of corruption, affecting inequality. Provided it holds true, we aim to study the interaction of such a law with the institutional framework of a state. By examining this relationship, we can establish a comparative to see if distortions such as corruption drive inequality or whether the general features of capitalism make inequality inevitable.

Key Variables of Interest Gini Co-efficient - Standard economic measure of income inequality, based on Lorenz Curve. A society that scores 0.0 on the Gini scale has perfect equality in income distribution. Corruption Perception Index - A ranking of countries according to the extent to which corruption is believed to exist. It is on a scale of zero to 100, with zero indicating high levels of corruption and 100 indicating low levels. r-g –Here the return to capital is defined as the real interest rate

Vast Majority of Macroeconomic Data collected from World Bank Datasets GINI Coefficients Collected from the Standardized World Income Inequality Dataset Corruptions Perceptions Index is sourced from Transparency International Democracy Index is sourced from the Polity IV dataset which is compiled by the Center for Systemic Peace. It is an 11 point scale from 0-11 based on democratic freedoms and institutional make-up. Fractionalization Data is collected from Quality of Governance Dataset. Data

Descriptive Statistics

Descriptive Statistics

Descriptive Statistics

Methodology • 2SLS Panel is the primary estimation strategy. Time Dummies, Country level clustering and xtscc were used to control for serial correlation For Corruption we included its square term For some r-g specifications we utilized an interaction term between CPI & r-g Quantile Regressions were also utilized to observe the effects of our key variables at different levels of inequality

Instruments Regulatory Quality Government Fractionalization Government Effectiveness

Key Findings •Corruption is a significant determinant of Inequality. In reality the effect is non-linear upon examination. •r-g is also is significant in most specifications •However, the interaction term is not •The effects of both r-g and corruption decrease at higher levels of inequality, with r-g being altogether insignificant

Variables Linear CPI OLS Fixed Effects Linear CPI IV Non-Linear CPI OLS Non-Linear CPI IV Corruption -0.00259 -0.0976* 0.169*** 0.465*   (0.0136) (0.0589) (0.0333) (0.248) Corruption2 -0.00171*** -0.00476* (0.000274) (0.00274)

Non-Linear CPI Fixed Effects Non-Linear CPI IV Fixed Effects VARIABLES Non-Linear CPI Fixed Effects Non-Linear CPI IV Fixed Effects Non-Linear CPI Fixed Effects with (r-g)*CPI Non-Linear CPI IV Fixed Effects with (r-g)*CPI CPI 0.145** 0.256* 0.156** 0.298**   (0.0544) (0.139) (0.0554) CPI squared -0.00163*** -0.00204 -0.00173*** -0.00249* (0.000515) (0.00144) (0.000544) (0.00143) r-g 0.0179 0.0260** 0.0494* 0.0623** (0.0100) (0.0114) (0.0242) (0.0258) r-g_CPI -0.000737 -0.000947 (0.000570) (0.000677)

Quantile Findings

Limitations Lack of availability of Time series Education data Gini is an synthetic and vague measure of Inequality

Conclusion Combating Corruption can be a major step in reducing inequality However, the scale of improvement necessary may be out of reach Returns to Capital do have short term effects More efficient taxes on Capital are needed But largely institutional change is necessary

Appendix

Gov. Spending as share of GDP -0.0113 0.0237 -0.0464 -0.150* (0.0480) VARIABLES Linear CPI OLS Fixed Effects Linear CPI IV Non-Linear CPI OLS Non-Linear CPI IV Corruption -0.00259 -0.0976* 0.169*** 0.465*   (0.0136) (0.0589) (0.0333) (0.248) Corruption2 -0.00171*** -0.00476* (0.000274) (0.00274) Gross Savings 0.0497*** 0.0586*** 0.0377*** 0.00837 (0.0100) (0.0202) (0.0101) (0.0260) Economic Growth -0.0281 -0.0274 -0.0310 -0.0280 (0.0193) (0.0227) (0.0195) (0.0204) GDP per Capita 1.44e-05 6.60e-05 2.45e-05 5.21e-05 (7.71e-05) (6.97e-05) (7.68e-05) (6.98e-05) Inflation -0.0287 -0.0192 -0.0319 0.0182 (0.0242) (0.0284) (0.0249) (0.0272) Gov. Spending as share of GDP -0.0113 0.0237 -0.0464 -0.150* (0.0480) (0.0699) (0.0498) (0.0842) Trade Openness 0.00804 0.00842 0.00611 -0.00734 (0.00871) (0.00824) (0.00868) (0.00838) Unemployment Rate -0.0170 -0.00401 -0.0165 0.0348 (0.0359) (0.0407) (0.0368) (0.0357) Population Growth 0.180 0.161 0.187 -0.133 (0.215) (0.238) (0.205) (0.213) Fractionalization 2.625*** 1.208 2.878*** 1.818 (0.705) (1.065) (0.731) (1.119) Natural Resource Rents as % of GDP -0.0953*** -0.106*** -0.0874*** -0.0608** (0.0173) (0.0221) (0.0166) (0.0277) Democracy 0.167 0.354 0.146 0.254 (0.170) (0.166) (0.203) Tax Revenue as % of GDP -0.0198 -0.0215 -0.0353 -0.0759** (0.0278) (0.0282) (0.0306) (0.0348) Years Since Independence 0.187*** 0.0840 0.172*** -0.561 (0.0151) (0.341) (0.381) Stock Market Capitalization -0.00231 -0.00116 -0.00217 -0.00383 (0.00330) (0.00291) (0.00333) (0.00297) Observations 634 591 544 R-squared 0.045 0.049 Number of country 71 67 rk Wald F-Stat 31.349 7.158 Stock-Yogo 10% Maximal IV size (19.93) (7.03)

Non-Linear CPI Fixed Effects Non-Linear CPI IV Fixed Effects VARIABLES Non-Linear CPI Fixed Effects Non-Linear CPI IV Fixed Effects Non-Linear CPI Fixed Effects with (r-g)*CPI Non-Linear CPI IV Fixed Effects with (r-g)*CPI   CPI 0.145** 0.256* 0.156** 0.298** (0.0544) (0.139) (0.0554) CPI squared -0.00163*** -0.00204 -0.00173*** -0.00249* (0.000515) (0.00144) (0.000544) (0.00143) r-g 0.0179 0.0260** 0.0494* 0.0623** (0.0100) (0.0114) (0.0242) (0.0258) r-g_CPI -0.000737 -0.000947 (0.000570) (0.000677) Gross Savings 0.0196* 0.0205 0.0229** 0.0235 (0.00920) (0.0217) (0.00932) (0.0216) GDP per capita 0.000298*** 0.000222** 0.000282*** 0.000211** (7.33e-05) (9.97e-05) (6.77e-05) (0.000102) Inflation -0.0189 0.0245 -0.0132 0.0303* (0.0278) (0.0181) (0.0253) (0.0178) Gov. Spending as % of GDP -0.111 -0.203*** -0.112 -0.209*** (0.0910) (0.0731) (0.0914) (0.0729) Trade Openness 0.00366 -0.0149 0.00264 -0.0171 (0.00951) (0.0112) (0.00940) (0.0116) Unemployment Rate 0.0339 0.0743 0.0375 0.0808 (0.0422) (0.0495) (0.0411) (0.0510) Population Growth 0.613** 0.227 0.646** 0.284 (0.236) (0.280) (0.247) (0.285) Fractionalization 1.272 0.870 1.350 1.001 (0.814) (1.001) (0.851) (1.013) Natural Resource Rent as % of GDP -0.0763*** -0.0583** -0.0772*** -0.0579** (0.0157) (0.0252) (0.0156) (0.0259) Tax Revenue 0.00940 -0.0191 0.00900 -0.0183 (0.0165) (0.0174) (0.0164) Years Since Independence 0.252*** -0.661 -0.632 (0.0305) (0.526) (0.0309) (0.536) Observations 569 477 R-squared 0.112 0.104 Number of country 78 69 rk Wald F-Stat 30.494 21.142 Stock-Yogo 10% Maximal IV size (7.03) (not available)

Gov. Spending as share of GDP -0.119 -0.177 -0.145 -0.156 -0.139 VARIABLES 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Corruption -0.168** -0.114 -0.0593 -0.134*** -0.0685* -0.0657* -0.0551* -0.0761** 0.0208   (0.0733) (0.0758) (0.0649) (0.0416) (0.0379) (0.0361) (0.0315) (0.0350) (0.0784) r-g 0.174 0.234*** 0.245*** 0.214*** 0.175*** 0.157*** 0.128*** 0.0646 0.0221 (0.194) (0.0828) (0.0450) (0.0470) (0.0418) (0.0419) (0.0318) (0.0417) (0.0402) Gross Savings 0.0379 0.0160 0.0660 0.0607 0.0567 0.00243 -0.0743 -0.148 -0.00914 (0.105) (0.0832) (0.0746) (0.0747) (0.0715) (0.0910) (0.0982) (0.101) (0.0954) Economic Growth 0.187 0.204 0.223* 0.239** 0.275** 0.283** 0.313*** 0.146 0.180* (0.179) (0.126) (0.119) (0.125) (0.118) (0.111) (0.131) (0.107) GDP per Capita -0.000134 -0.000195 -0.000317*** -0.000279*** -0.000282*** -0.000303*** -0.000261*** -0.000230*** -0.000395*** (0.000105) (0.000120) (0.000107) (6.37e-05) (5.55e-05) (5.01e-05) (4.66e-05) (4.56e-05) (0.000106) Inflation -0.0837 -0.0461 -0.0640 -0.128 -0.0536 -0.00407 0.0534 0.0722 -0.00915 (0.189) (0.142) (0.116) (0.0997) (0.106) (0.124) (0.0981) Gov. Spending as share of GDP -0.119 -0.177 -0.145 -0.156 -0.139 -0.241 -0.468** -0.544*** -0.0221 (0.148) (0.133) (0.103) (0.128) (0.139) (0.166) (0.188) (0.173) (0.321) Trade Openness -0.0426** -0.0412** -0.0447*** -0.0540*** -0.0462*** -0.0367*** -0.0314*** -0.0335*** -0.0436*** (0.0195) (0.0189) (0.0168) (0.0125) (0.0116) (0.0117) (0.00884) (0.00960) (0.0147) Unemployment Rate 0.102 0.212 0.104 0.111 0.205 0.386** 0.554*** 0.578*** 0.489*** (0.239) (0.146) (0.144) (0.104) (0.190) (0.174) (0.156) Population Growth 2.732*** 2.747*** 2.422*** 2.029** 1.454** 1.724*** 2.010*** 2.486*** 3.100*** (0.617) (0.583) (0.687) (0.789) (0.577) (0.586) (0.524) (0.591) (0.590) Fractionalization -0.926 3.007 3.588 4.468 5.728* 5.396* 5.094 -0.432 -7.366 (4.724) (3.381) (3.205) (4.018) (3.144) (2.859) (3.765) (5.207) (7.745) Natural Resource % of GDP 0.132** 0.145*** 0.139*** 0.125** 0.116** 0.163*** 0.185*** 0.161*** 0.0396 (0.0590) (0.0473) (0.0489) (0.0584) (0.0490) (0.0589) (0.0556) (0.0582) (0.0654) Democracy 1.007*** 0.930*** 1.059*** 0.810** 0.555*** 0.771*** 0.657** 0.514* -0.0146 (0.240) (0.241) (0.285) (0.354) (0.208) (0.260) (0.272) (0.304) (0.494) Tax Revenue as % of GDP 0.0652 0.0582 0.0802 0.204*** 0.160*** 0.0925* 0.0679* 0.0502 0.0793** (0.0823) (0.0807) (0.0801) (0.0561) (0.0461) (0.0474) (0.0370) (0.0322) (0.0400) Years Since Independence -0.000564 -0.00112 -0.00187* -0.00348*** -0.00373*** -0.00432*** -0.00406*** -0.00485*** 0.00419 (0.00108) (0.00112) (0.00114) (0.00118) (0.00115) (0.00110) (0.00111) (0.00619) Stock Market Capitalization 0.0489*** 0.0454*** 0.0543*** 0.0699*** 0.0677*** 0.0565*** 0.0441*** 0.0362*** 0.0112 (0.0106) (0.0104) (0.00870) (0.0118) (0.0110) (0.0111) (0.0115) (0.0105) Constant 30.74*** 29.69*** 28.93*** 33.91*** 33.26*** 34.83*** 39.77*** 50.05*** 50.70*** (7.117) (4.752) (4.704) (4.359) (4.314) (4.534) (5.437) (6.355) (7.344) Observations 421

Non-Linear CPI Fixed Effects with (r-g)*CPI VARIABLES Linear CPI IV FE Non-Linear CPI IV FE Non-Linear CPI Fixed Effects with (r-g)*CPI CPI -0.00185 -0.625* -0.613* -0.659*   (0.0572) (0.367) (0.338) (0.373) CPI squared 0.00637* 0.00587* 0.00632* (0.00358) (0.00345) (0.00361) r-g 0.0177 -0.0197 (0.0200) (0.111) r-g_CPI 0.000860 (0.00235) Gross Savings Rate -0.000622 0.0247 0.0265 0.0225 (0.0398) (0.0519) (0.0589) (0.0587) GDP per Capita -3.72e-05 -4.43e-06 7.11e-05 8.84e-05 (0.000111) (0.000124) (0.000247) (0.000267) Inflation 0.0329 0.121** 0.109* 0.104 (0.0558) (0.0516) (0.0610) (0.0670) Gov. Spending as share of GDP 0.101 0.271* 0.201 0.200 (0.0921) (0.140) (0.127) (0.128) Trade Openness 0.0137 0.0189 0.0168 (0.0105) (0.0141) (0.0193) (0.0217) Unemployment Rate -0.0268 -0.0189 0.0366 0.0346 (0.0413) (0.0493) (0.0788) (0.0787) Population Growth -0.0399 -0.329 -0.306 -0.356 (0.352) (0.361) (0.505) (0.519) Fractionalization -3.544* -4.387 -5.756* -6.082* (1.934) (2.711) (3.076) (3.452) Natural Resource Rents as % of GDP 0.0925 0.186* 0.214** 0.210** (0.0833) (0.0966) (0.0985) (0.0997) Democracy 0.0197** 0.0329** 0.0528 0.0704 (0.00891) (0.329) (0.336) Tax Revenue -0.0396 0.0242 0.0928 0.102 (0.0293) (0.0524) (0.0972) (0.107) Years Since Independence 1.038** 1.766*** 1.846** 1.842** (0.451) (0.659) (0.853) (0.859) Stock Market Capitalization 9.97e-06 -0.000624 0.00268 0.00291 (0.00382) (0.00515) (0.00820) (0.00842) Observations 326 304 209 R-squared 0.100 -0.044 0.057 0.037 Number of countries 56 43 Wald F-Stat 32.474 8.531 11.775 8.447 Stock-Yogo 10% Maximal IV size (19.93) (7.03) (not known)

IneratciontermmodelCpi VARIABLES LinearIV NonLinearCPIIV NonLinearCPI_sqrIV NonLinearrgCPI NonlinearrgCpi_sqr IneratciontermmodelCpi Interactioncpi_sqr Interctionr-g_cpi   govfrac -0.456 (1.930) Regulatoryquality L1 7.99*** (1.48) 602*** (139) 7.53*** (1.35) 486*** (130) 7.29*** (7.36) 454*** 4.703 (30.46) goveffctiveness 8.914*** (2.584) goveffctiveness_sqr 2.79*** (0.535) 312*** (67.1) 2.72*** (0.670) 416*** (92.5) 2.84*** (0.678) 431*** (93.7) -26.5 (17.4) Inter3 0.0425 (0.0244) 5.60 (2.70) 17.8*** (1.49) rg -0.0437 (0.0277) -2.87 (3.26) -0.0510 (0.0285) -3.83 (3.37) 34.7*** (1.58 gsavings 0.0914 (0.0607) 0.066 (0.0504) -0.521 (4.33) 0.0583 (0.0470) 3.49 (4.49) 0.0470 (0.0478) 2.00 (4.53) -0.604 (1.06) ecogrth -0.0110 -0.02505 -4.41 (0.0632) (4.69) GDPcapita 0.000127 0.000499 0.0564 0.00042 0.0605 0.000441 0.0632 -0.0135** (0.000134) (0.000184) (0.0196) (0.000223) (0.0222) (0.000224) (0.0220) (0.00535) inflation -0.0631 -0.0374 -5.09 -0.06143 -5.78 -0.0725 -7.23 1.50 (0.0840) (0.0772) (8.39) (0.0509) (5.35) (0.0521) (5.48) (2.07) govspedgdp 0.339 0.350** 17.06 0.427** 29.7 0.433*** 30.41** 0.747 (0.214) (0.161) (14.67) (0.124) (12.4) (12.32 (2.56) trdopn 0.0542** 0.0545** 4.42 0.051** 2.79 0.0550*** 3.27 0.168 (0.0261) (0.0187) (2.14) (0.017) (1.73) (0.0172) (1.72) (0.354) unemploymentrate -0.168 0.00748 0.258 0.149** 10.67 0.125 7.52 -1.60 (0.135) (0.0851) (8.02) (0.0735) (6.96) (0.0732) (6.93) (2.79) PopulationGrowth -0.735* 0.264 30.07 0.681 155** 0.648 151 4.02 (0.397) (74.08) (0.554) (66.7) (21.0) frac -4.726 -5.53 -477 -1.99 -73.1 -2.21 -90.1 29.8 (4.010) (2.39) (209) (1.70) (137) (37.1) natrlrpergdp -0.196** -0.0697 -3.53 -0.0474 -0.395 -0.0455 -0.146 -0.625 (0.0933) (0.0616) (5.38) (0.0625) (5.25) (0.0649) (5.63) (1.42) democ -0.00944 0.233 12.09 (0.0306) (0.165) (15.3) taxrev 0.0179 -0.0445 -12.07 0.272*** 29.3*** -0.791 (0.183) (0.0937) (9.67) (0.0802) (9.16) (0.0803) (9.18) (0.826) yearindp 0.152 2.16 112 4.23*** 342*** 4.16*** 333*** 27.7 (0.114) (0.904) (103) (0.926) (98.6) (0.962) (98.4) (17.1) stmktcap -0.00339 -0.00249 -0.196 (0.00723) (0.861) Constant 14.76 (17.97) Observations 676 R-squared 0.213 Number of country 78

Non-Linear w/ interaction cpi -0.102 0.465* 0.256* 0.298** (0.0621) VARIABLES Linear Model Non-Linear Non-Linear w/ r-g Non-Linear w/ interaction   cpi -0.102 0.465* 0.256* 0.298** (0.0621) (0.248) (0.139) cpi_sqr -0.00476* -0.00204 -0.00249* (0.00274) (0.00144) (0.00143) rg 0.0260** 0.0623** (0.0114) (0.0258) rg_cpi -0.000947 (0.000677) (0.0228) (0.0204) GDPcapita 6.82e-05 5.21e-05 0.000222** 0.000211** (7.06e-05) (6.98e-05) (9.97e-05) (0.000102) inflation -0.0195 0.0182 0.0245 0.0303* (0.0286) (0.0272) (0.0181) (0.0178) govspedgdp 0.0255 -0.150* -0.203*** -0.209*** (0.0705) (0.0842) (0.0731) (0.0729) trdopn 0.00862 -0.00734 -0.0149 -0.0171 (0.00831) (0.00838) (0.0112) (0.0116) unemploymentrate -0.00443 0.0348 0.0743 0.0808 (0.0409) (0.0357) (0.0495) (0.0510) PopulationGrowth 0.161 -0.133 0.227 0.284 (0.239) (0.213) (0.280) (0.285) frac 1.169 1.818 0.870 1.001 (1.077) (1.119) (1.001) (1.013) natrlrpergdp -0.107*** -0.0608** -0.0583** -0.0579** (0.0223) (0.0277) (0.0252) (0.0259) democ 0.356* 0.254 (0.216) (0.203) taxrev -0.0212 -0.0759** -0.0191 -0.0183 (0.0285) (0.0348) (0.0174) yearindp 0.0930 -0.561 -0.661 -0.632 (0.344) (0.381) (0.526) (0.536) stmktcap -0.00115 -0.00383 (0.00291) (0.00297) Observations 591 544 477 R-squared 0.040 0.049 0.112 0.104 Number of country 67 69 Stock & Yogo Critical Value 31.349 7.158 30.494 21.142

VARIABLES Wih Education   cpi 0.391*** (0.124) cpi_sqr -0.00365*** (0.00106) rg 0.0239 (0.0281) gsavings 0.0836 (0.0979) GDPcapita 0.000437** (0.000211) inflation 0.00555 (0.0527) govspedgdp -0.245 (0.167) trdopn -0.00793 (0.0241) unemploymentrate -0.117 (0.0970) PopulationGrowth 1.331* (0.700) frac 3.330* (1.796) natrlrpergdp -0.137** (0.0553) lsc 0.00404 (0.0410) taxrev -0.0507 (0.0600) yearindp -0.210* (0.122) Constant 47.75*** (10.91) Observations 162 Number of country 74 R-squared 0.316