The Economics of Corruption: Measurement, Causes and Effects Fabio Padovano Public Finance - Introductory

Public Finance - Introductory Introduction Widespread phenomenon in poor countries: corruption Often suggested corruption is bad for growth Challenges for researchers: Corruption hard to define, even harder to measure Difficult to isolate effects of corruption in cross-country data from those of other covariates Theoretically not always clear how corruption might harm growth Even if we know that corruption is bad for growth, not obvious what can we do about it Public Finance - Introductory

Public Finance - Introductory What is corruption? Misuse of public office for private gain Often same as bribes, i.e., payments to government officials in return for favors Not at all the same as taxation: revenue not used for public good, higher transaction costs, non-enforceable contracts Not the same as lobbying: benefits of corruption (bribes) more firm- specific, less permanent, than lobbying Not always/exactly the same as rent-seeking : the latter tends to be the result of government intervention (e.g., trade restrictions), rather than the action of an individual civil servant Public Finance - Introductory

Public Finance - Introductory Types of corruption Economic theory (and legal systems) distinguishes 3 types of corruption (Forti, 2003) : public-private; public-public; private-private Usually focus on a) and b) (i.e. political and administrative corruption) Economists usually hold that corruption requires the existence of three elements (Aidt, 2003): The discretionary power of a policy-maker or bureaucrat to allocate economic resources, define rules and enforce contracts An economic rent or utility associated to the discretionary power A disutility associated to the probability to be caught and punished Public Finance - Introductory

Public Finance - Introductory Measuring corruption There are different methods to measure corruption, none devoid of conceptual or statistical problems Main difficulties are the definition of corruption, lack of objective data, risk of under-reporting, measurement errors Three main types of indicators Subjective indicators based on perceptions Judicial indicators based on Court data Objective measures based on direct observations and experiences They do not coincide (Padovano, Voigt 2011) Public Finance - Introductory

Subjective vs. objective Public Finance - Introductory

Public Finance - Introductory

Determinants of corruption Democracy, education and income Economic freedom Public sector size Ethnic fragmentation and redistribution Efficiency wages Public Finance - Introductory

Public Finance - Introductory Democracy, education and income (Modernization theory aka Lipset hypothesis) Risk of being caught may be higher in more democratic systems where competitors for office have an incentive to disclose and publicize the incumbent’s misuse of office during the elections Voters with more education and income are both more willing and capable to monitor public officials and to take action when these public officials violate the law Greater civic engagement may lead to closer monitoring (Putnam, 2003) Cross-country analyses support this hypothesis ( i.e. Glaeser et al., 2004; Djankov et al., 2003) Public Finance - Introductory

Economic freedom and world trade Competitive markets and openness to trade reduce corruption (Paldam, 2002; Treisman, 2000; Lambsdorff, 2006) Tariffs and non-tariffs barriers to the international trade generates corruption (Herzfeld and Weiss, 2003, Treisman, 2000) Endowment of natural resources like oil, minerals, gold increase the illegal rents → “Natural resources curse”(Ades and Di Tella, 1999) Public Finance - Introductory

Public Finance - Introductory Size of public sector More regulations (production of law, taxation or public expenditure) and greater government size create a potential for corruption → more resources to steal and more rules to subvert (De Soto, 1898; Tanzi, 1994; Glaeser and Shleifer, 2003; Adsera et al., 2003) Many empirical analyses (i.e. Gupta, Davoodi and Tjongson, 2002; Glaeser and Shleifer (2003); Adsera, Boix and Payne (2003) find that an increase in public expenditure is associated to higher corruption especially in sectors characterized by monopolistic supply, high technological content and more discretionary and less transparent management of the expenditure What about the Scandinavian paradox? Public Finance - Introductory

Ethnic fragmentation and redistribution If an area is worn out by ethnic divisions and leaders tend to allocate resources towards groups of their own ethnicity, then members of one ethnic group might continue to support a leader of their own group, even if he is known to be corrupt because of redistributive interests (Mauro, 1995; Fearon and Laitin, 1996; Alesina eLa Ferrara, 2005) Other forms of division, such as income inequality, may also reduce voters’ desire to oppose corruption since as voters become more diverse along the income line, they will focus on the redistribution rather than on the honesty of government officials (Mauro, 1995 and Alesina et al., 2002) Public Finance - Introductory

Corruption and efficiency wages Relationship between the incentives’ structure and corruption → higher salaries can solve problems of moral hazard (ex post opportunistic behavior of the public official → reduction of monitoring costs) adverse selection (ex ante difficulty to distinguish between a honest and dishonest official) Efficiency wages could not work if corrupt bureaucrat requires a higher bribe to counterbalance the risk of losing his job (Besley and McLaren, 1993) Empirical research is mixed: Van Rijckeghem and Weder (2001) find that corruption is lower in countries where public officials are better paid than people that work in the private sector with similar level of responsibility Di Tella and Schargrodsky (2003) do not find any empirical support to this hypothesis Public Finance - Introductory