Local Corruption and the Global Economy.

• Author: Wei, Shang-Jin

Shang-Jin Wei [*]

Corruption, like cockroaches, has co-existed with human society for a long time. Its role in economic development is controversial. According to Samuel P. Huntington, the distinguished Harvard political scientist "[i]n terms of economic growth, the only thing worse than a society with a rigid, over-centralized, dishonest bureaucracy is one with a rigid, overcentralized and honest bureaucracy." [1] On the other hand, Lawrence Summers, the current Secretary of the U.S. Treasury and previously a Harvard economics professor and NBER Research Associate, said otherwise: "If you look under most banking crises, there's always a degree of fraud and abuse, and there's often a large amount of criminal activity. Corruption threatens growth and stability in many other ways as well: by discouraging business, undermining legal notions of property rights and perpetuating vested interests." [2]

In this report, I summarize some papers that explore different consequences

of corruption, particularly its interaction with international investment and finance. [3] The goal is to address a number of questions: Does corruption on balance add "grease" or "sand" to the wheels of commerce? How costly is corruption to international investors relative to the effect of a tax? And, does corruption increase the chance of a currency crisis?

Bribery in the Economies: Grease or Sand?

Mauro conducted the first empirical study of the relationship between corruption and economic growth. [4] Within a standard growth regression, he embedded a subjective measure of corruption across countries devised by the "in-house experts" at Business International (a consulting firm) and found that countries perceived to be more corrupt tend to grow more slowly. A potential problem with studies based on crosscountry regressions, though, is that many things in a country are correlated, so it may be difficult to disentangle the effects attributable solely to corruption. For example, corruption may be highly correlated with the poor quality of public servants, a factor that may retard growth whether corruption exists or not.

One way to get around this is to examine evidence at the firm level. In what we believe is the first study of this kind, Daniel Kaufmann and [5] use three worldwide firm surveys to examine the "efficient grease hypothesis"; namely, that firms that pay more bribes face less red tape and have better access to public funds and bank loans (hence reducing their cost of capital). In short, we examine the hypothesis that bribery "greases the wheels" of commerce. To guide our analysis, we first derive a simple model. As the literature suggests, [6] the "bribery-as-grease" hypothesis depends on the assumption that red tape is set exogenously. In our model, we therefore let the bureaucrat who takes the bribes also set the red tape. We distinguish between nominal bureaucratic harassment (for example, statutory tax and tariff rates, or the waiting time for a permit without bribery) and effective harassment (for example, actual tax and tariff rates, or queuing time after the firm pays a bribe).

Furthermore, we assume that different firms have different outside options because of their individual characteristics. This implies that the maximum degree of harassment tolerated also would vary across firms. For example, foreign firms would tolerate less harassment than domestic ones because they could relocate more easily to a different country. Overall, U.S. firms may tolerate the least harassment because, up until very recently, the United States was the only major source country that fined and criminalized its firms for paying bribes to foreign officials. [7] Finally, firms dependent on more specialized inputs from the host country (for example, oil or gold) are less able to resist bribery demands from corrupt officials.

Not surprisingly, in equilibrium the bureaucrat would impose just enough nominal harassment to obtain the maximum bribes without inducing the firm to leave the country. As a consequence, nominal...