The World Bank Governance & Anticorruption Core Course, page 1 A Corruption / Growth Paradox in South Asia? Aart Kraay DECRG Comments at Core Course on Public Sector Governance and AntiCorruption Governance & Anticorruption Core Course

The World Bank Governance & Anticorruption Core Course, page 2 The Paradox Stylized version of paradox: “[Insert your favourite country here] is one of the most corrupt countries in the world and also one of the world’s fastest growing countries” Is there really a paradox? –think about countries in South Asia (especially Bangladesh) –think about distinction between long and short run –think about types of institutions that matter –think about isolating causal effects

The World Bank Governance & Anticorruption Core Course, page 3 Is There Really a Governance-Growth Paradox (In the Medium Run At Least?)

The World Bank Governance & Anticorruption Core Course, page 4 Corruption and Growth in Long Run

The World Bank Governance & Anticorruption Core Course, page 5 Is There A Paradox in the Long Run? To know whether there is a paradox in long-run relationship, we need to: –identify direction of causality –control for other types of institutions that matter Two types of institutions (following Acemoglu-Johnson (2005), details on South Asia in Fernandes and Kraay (2005)) –“property rights institutions” (PRI): is private property secure from state predation? (Corruption – Settler Mortality) –“contracting institutions” (CI): do institutions support transactions between private parties? (Days to clear cheque)

The World Bank Governance & Anticorruption Core Course, page 6 Sorting Out Causality (...Sort of... So We Can Have a Picture) Estimated Causal Effect

The World Bank Governance & Anticorruption Core Course, page 7 Sorting Out Causality, Cont’d First look at “deep” determinants of institutions –Settler Mortality  Property Rights Institutions India: surprisingly good PRI Bangladesh, Pakistan: surprisingly weak PRI –British Legal Origins  Contracting Institutions India, Pakistan: surprisingly weak CI Bangladesh: surprisingly good CI

The World Bank Governance & Anticorruption Core Course, page 8 Sorting Out Causality, Cont’d Where do countries in South Asia stand in this causal relationship? ln(GDP/Capita) =  0 +  1 PRI +  2 CI + e Typically find PRI matters much more than CI –possibility of “contracting around” bad CI? Bangladesh, Pakistan have surprisingly large positive residuals: per capita incomes 2-3 times higher than what we would expect given their (lousy) PRI and CI India has surprisingly large negative residual: per capita income half what we would expect given its (decent) PRI and CI

The World Bank Governance & Anticorruption Core Course, page 9 Governance and Long-Run Growth: Possibly More Interesting Paradoxes in SA Interesting paradox is in the long-run relationship –short-run relationship is pretty noisy How did Bangladesh and Pakistan get so rich with bad institutions? –Bangladesh has especially weak PRI which matter most for growth: how does “contracting around” work here? –Are past income gains “fragile” with sobering implications for long-run growth? Why has India’s good PRI not translated into better growth?