Determinants of economic corruption: a cross-country comparison.

• Author: Ali, Abdiweli M.

In recent years, the detrimental effects of bureaucratic corruption gained attention from development economists as well as international financial institutions and policymakers. Corruption, which was previously ignored and mentioned only with caution, has taken a center stage. Nonetheless, corruption is not a new phenomenon. It is as old as government itself. The current literature on corruption highlights its harmful effects on growth (see Klitgaard 1988, Shleifer and Vishny 1993, Mauro 1995, Cheung 1996, and Bardhan 1997). However, until recently the growth literature did not adequately explain why corruption is low in some countries and endemic in others. (1) The relevant analytical problem is not to assess the harmfulness of corruption but why different political systems foster different levels of corruption. We cannot discern any useful prognosis from the literature on corruption so long as the causes of corruption are not clearly identified. Moreover, the empirical studies on the effects of corruption on economic growth are besieged by endogeneity problems. Few of these empirical studies take into account the possibility that economic growth or the lack of it can increase or decrease the level of corruption.

This article seeks to fill that gap by identifying the determinants of corruption and by examining the extent to which those factors--such as education, political regimes, the type of the state, ethnicity, judicial efficiency, political freedom, and the size of government--explain differences in corruption across countries. When the determinants of corruption are clearly identified, appropriate policy conclusions can then be drawn from the analysis, and policymakers can then design and implement measures to curb and control its harmful effects.

Alternative Views of Corruption

The prevailing view is that corruption is harmful to economic growth. Mauro (1995) finds that corruption lowers investment and, consequently, economic growth. Using data from a large sample of countries, he finds that corruption, red tape, and bureaucratic inefficiency are negatively correlated with economic growth. Klitgaard (1988) suggests that when political power translates corruptly into economic gains, corruption redistributes resources from the poor to the rich and encourages malfeasance and rent seeking. In corrupt societies, government bureaucrats compete for positions of economic power and spend their time and energy in the pursuit of rents. This rent-seeking activity, in turn, affects the capacity of public institutions to provide services. (2)

Corruption adversely distorts incentives and creates uncertainties about the expected benefits of productive activities, forcing entrepreneurs to undertake costly and inefficient loss-avoiding behaviors. Shleifer and Vishny (1993) suggest that corruption is a tax on economic activity that is more costly than legal taxes. Unlike taxation, corruption is illegal and real resources are wasted to avoid detection. The need to keep the transactions secret directs resources to hard-to-detect activities with no regard for economic consequences.

Contrary to this prevailing view that corruption is harmful to economic development, some studies suggest that it might be beneficial and enhance efficiency. (3) Left (1964) long ago proffered that corruption circumvents inefficient and cumbersome government regulations. He argues that corruption mitigates the distortionary effects of government policies and allows entrepreneurs to avoid bureaucratic delays. A direct payment to corrupt officials reduces the transactions cost of business and energizes corrupt civil servants who would have otherwise engaged in delaying tactics. (4) Left also claims that corruption generates a social benefit and serves as a mechanism for political participation and influence for minorities and foreign corporations. Left (1979: 328) remarks: "In most underdeveloped countries, interest groups are weak, and political parties rarely permit the participation of elements outside the contending cliques. Consequently, graft may be the only institution allowing other interests to achieve articulation and representation in the political process."

Scott (1972) also argued that what is considered corruption in the West is in fact a continuation of traditional gift giving in less developed countries (LDCs). The imposition of Western values and attitudes has transformed this traditional gift exchange in LDCs into corruption. Tullock (1996) also claims that illicit payments are a substitute for higher wages. Corruption therefore saves money for the government that it would have otherwise paid in higher salaries. Lui (1996) makes the case that what some people call corruption is nothing but a fee for underpriced services. He suggests that corruption restores the price mechanism and improves the allocation of resources in distorted and heavily regulated markets.

Reassessing the Relationship between Corruption and Economic Growth

Table 1 is a correlation matrix of the regression variables presumed to affect economic growth. A detailed description of the data is in the Appendix. The correlation coefficient for the relation between corruption in the 1980s and the 1990s is 0.73, showing that corruption was persistent over the years. Those countries with high levels of corruption in the 1980s continued to have high levels of corruption in the 1990s. Corruption breeds corruption, and the longer it persists the more endemic it becomes. Table 2 provides descriptive statistics for the regression variables. The mean and the median of corruption in the 1990s are higher than those of the 1980s. However, there is no conclusive evidence that corruption has increased worldwide in 1990s. The corruption indexes for the 1980s and 1990s were provided by different organizations. They cover different samples, and the nature and content of the survey questions might have been quite different.

Table 3 summarizes the empirical results employing the following core equation:

(1) Growth = [β.sub.0] + [β.sub.1] (initial GDP) + [β.sub.2] (population growth) + [β.sub.3] (education) + [β.sub.5](other variables of interest) + ζ.

The control variables are standard in the literature. (5) They are the initial GDP level, the secondary school enrollment rate, and the population growth rate. Table 3 also includes dummy variables for Africa and Latin America to account for continent-specific characteristics.

In Model 1 of Table 3, the corruption index for the 1980s is added to the above specification as an additional variable of interest. The coefficient of corruption is negative and highly significant when other correlates of growth are included in the regression equation. However, the prevalence of corruption can be a by-product of economic growth as well as its cause. The possibility of corruption being a function of economic growth creates an endogeneity problem. There is a plausible argument that lower economic growth could lead to higher corruption or higher corruption could lead to lower growth rate. Model 2 examines this potential bias using a two-stage least-squares approach. To correct for endogeneity, we used ethnolinguistic fractionalization as an instrumental variable; a measure of ethnolinguistic fragmentation. (6) The fractionalization index is frequently used in the growth literature and measures the probability that two randomly selected persons from a given country will not belong to the same ethnolinguistic group (Easterly and Levine 1997, Mauro 1995). The higher the index the more heterogeneous and fragmented the society and the lower the probability that economic agents are treated equally and fairly.

Ethnolinguistic fractionalization is not correlated to economic growth but is significantly and negatively correlated with corruption. As shown in Table 1, the simple correlation coefficient between corruption in the 1980s and ethnolinguistic fractionalization is 0.61, while the correlation between corruption in the 1990s and ethnolinguistic fractionalization is 0.63. The estimated results...