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 low- red-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