Does corruption harm economic growth?

by on November 19, 2012 at 1:24 pm in Economics, Education, Political Science, Uncategorized | Permalink

Chris Blattman says maybe not.  Excerpt:

The reasons that corruption should hurt growth are so persuasive that economists have been pretty surprised not to find much evidence.  One team reviewed 41 different cross-country studies of corruption and development. Two-thirds of the studies don’t even find a negative correlation. Cross-country studies have mostly bad data and empirics, so we should not rest here. But Jacob Svensson has a nice overview of the broader evidence and draws the same conclusion: there’s not much to show that corruption reduces growth on net.

I worry more about corruption than those remarks would indicate, though I agree with Chris that the issue isn’t nearly as important as stopping a civil war.

First, I see a strong correlation between high levels of per capita income and low corruption.  (I don’t worry about the lack of correlation with growth rates because, for one thing, poor countries, even many corrupt ones, may grow more rapidly for reasons related to the Solow model.)  The causality here is hard to sort out, but there is plenty of micro evidence that corruption harms prosperity; it’s not just an aesthetic taste of wealthy people to limit corruption, the way they might buy nice interior drapes.

Furthermore, the correct corruption/poverty model may have multiple equilibria, depending on expectations.  In that setting, making your country “look clean” may improve outcomes by shifting the economy up to better equilibria, even if lower corruption isn’t a direct cause of greater prosperity.  There is worse advice than “Act like a rich country, and in the meantime you may become one,” at least provided you do not take this as liberty to spend above your means or to slack off with the work hours.

Second, even high levels of wealth will in some regards bring more corruption, especially as a country moves out of “fourth world” status or other forms of extreme poverty.  Corruption very often rises with complexity and so along some margins it is correlated with wealth levels too.  Similarly, we find that economic growth tends to bring more sexual harassment in the workplace, if only because more women are working outside the home.  Yet it is still correct to think of the harassment as a very real negative, as is corruption.

In any case, this week’s new videos are up at MRU and they cover the topic of corruption, go over and take a look.  Here is one video on the causal question about corruption and growth.  Here is our video on the causes and predictors of corruption, historically speaking.  Here is our video on how corruption can trap economies.

mw November 19, 2012 at 1:51 pm

GDP-per-capita aside, it’s pretty clear that it makes growth less equitable in any case.

david November 19, 2012 at 3:25 pm

Not necessarily. In many cases ‘corruption’ is paid out to entrenched interest groups. It grows out of popular pressure to preserve traditional tithes from wealthy minorities to the agricultural majority whilst maintaining the illusion of modern – possibly “socialist” – egalitarianism.

PK November 19, 2012 at 2:03 pm

It’s a nice display of how academic economists can’t see forest for the trees.

dan1111 November 19, 2012 at 2:19 pm

Or is it that they can’t see the trees for the forest…

Andrew' November 19, 2012 at 2:31 pm

They can’t stand to waste a view.

dan1111 November 19, 2012 at 2:53 pm

If a tree falls in the forest, but no economics study finds a positive correlation between the tree and the ground, did it really happen?

Andrew' November 19, 2012 at 2:57 pm

The study or the treefall?

Ed November 19, 2012 at 2:39 pm

How do these people define and measure “corruption”?

Tyler Cowen November 19, 2012 at 3:10 pm

See our video on that!

prior_approval November 20, 2012 at 1:00 am

Watch the video, and in around five minutes, a deep understanding of the intricacies of corruption/business as usual/different perspectives within cultures and societies with thousands of years of history will be yours in its entirety.

And the video, being free, isn’t even trying to sell you anything – nothing even hinting at any hidden motives, everything completely above board, as notice the reply from the general director of the Mercatus Center suggesting you just need to watch a video to understand a working definition of corruption which undoubtedly meets with the full approval of the people that paid for over 1250 (or 1300 – Inqbation list both numbers) project hours to set up a shiny new educational web site.

Andrew' November 20, 2012 at 5:28 am

1250 hours would be at most $125,000 and maybe 1/3rd to 1/2 of that. I’m surprised it took even that much. I’ve wasted far more than that on things that helped nobody!

And you have it bass ackwards anyway. Donors don’t go find people they can manipulate, as if a Tyler Cowen or Alex Tabarrok don’t make their living saying exactly what is on their minds. Donors find people already doing what they appreciate.

Andrew' November 20, 2012 at 5:37 am

Hmmm, let me go find the place where George Soros (or half of the government for that matter) gives their money to produce things that are by definition and design utterly available for public review and rebuttal…oh wait…I can’t because those don’t exist.

Okay, so maybe half the government is a bit of an exaggeration. But the problem is not (just) the published parts (which are clearly biased too). The problem is the grants pay for the all the other parts too. You seem to be hiding behind the assumption that anything not supported by industrialists is unbiased. That we have (because we need) something called “Freedom of Information Act” memos says something.

If you are criticizing free videos, what are we talking about here? Seriously, what is your accusation? Or is “Koch!” some kind of accusation of good game? These guys have to be the worst secret conspirators of all time. I’ve read his damn book.

Barkley Rosser November 19, 2012 at 3:13 pm

See Blackburn and Forgues-Puccio, “Why is corruption less harmful in some countries than others?” JEBO 2009, 72, 1-34. Answer is that it is not so harmful in countries where it is “organized” and predictable (think China). People know whom they have to bribe and how much to pay. It is disorganized and arbitrary corruption that messes up economic growth.

msgkings November 20, 2012 at 11:53 am

So ‘organized’ corruption would be basically extra, predictable costs. Almost like a tax. So taxes are not so harmful?

msgkings November 20, 2012 at 11:57 am

Basically I would argue that predictable, reasonable levels of taxation are indeed not so harmful. It’s the predictability that makes them (not) so. Which jibes with some of the current thought that part of our recent growth stagnation in the US is the currently disorganized and unpredictable debate about tax (and spending) levels. Almost any ‘final’ resolution would be better than this current not knowing phase.

collin November 19, 2012 at 3:36 pm

Glad to see economist disagreeing with all the message movies of the 1950s. Joking aside, I would suggest the increase of crime and corruption is part of the beginning of econmic growth. When economic growth really gets started most societies tend to have a lot of inequality so crime accelerates as Goodfellas well stated “working guy try to cut a few corners to make some extra bucks.” Thus corruption now accelerates to facilitate this activity.

My guess rich nations have less crime and corruption as most people no longer need to risk their lives to make a few extra bucks and they do not want to risk their livelihood for side money. (My guess corruption in police forces is down dramatically the last 50 years.)

uffy November 19, 2012 at 3:58 pm

And hence we have found the cause of the Great Stagnation is that prosperous people no longer need to risk everything to make a marginal improvement in their incomes.

msgkings November 20, 2012 at 12:00 pm

If so that’s kind of a good thing, isn’t it? That most people no longer need to risk their lives to make a few extra bucks?
#firstworldproblems

Anon. November 19, 2012 at 4:03 pm

One potential explanation has to do with the effectiveness of government in the presence of weak institutions. Bribery actually gets shit done, and officials simply take a part of the pie. If it’s not possible to bride you get the worst possible outcome of the pie not growing at all because the lack of bribery stops many positive NPV projects from happening.

Doug November 19, 2012 at 4:15 pm

Go to the website for the Economic Freedom Index and download the data. Regress the log GDP per capita against the 10 economic freedom rankings (property rights, freedom from corruption, government spending, fiscal freedom, business freedom, labor freedom, monetary freedom, trade freedom, investment freedom and financial freedom).

http://www.heritage.org/index/ranking?src=home

You’ll find that in both multiple and regressions by far the most important factors in predicting a nation’s wealth levels are property rights and corruption. Followed by a high ranking for business freedom, trade freedom, and investment freedom. But property rights and corruption in isolation explain more than half the variance explained by adding other measures of economic freedom.

To a first order approximation free market capitalism works because free market economies tend to have strong property rights and low corruption. This goes a long way to explaining why Northern European democracies have high per capita GDP levels despite having high tax rates and a lot of regulation. They may deviate a lot from free market principles but at the end of they day the rules of the game are well known, everyone knows them in advance and they’re administered fairly. So enterprises have a comparatively easy time adapting to government regulation.

This also explain why other countries that rank high on the economic freedom index are still stuck at middle income levels (e.g. Chile, Mauritius, Lithuania, St. Lucia). They have overall small government intervention, but high levels of corruption and insecure property rights relative to other Western nations at similar rankings.

Furthermore when you divide the data set into developing and developed countries and run separate regression you find that corruption/property rights are even more important for developed countries than developed countries. Basically it’s easier to go from low income to middle income with high levels of corruption, especially if you ease government intervention in other areas. But to achieving the very high income levels is very difficult without super secure property rights and virtually non-existent corruption (at least by global standards).

While I’m on the topic, under this model the increase in corruption in the United States has gone a long way to impacting our income levels. If the US had maintained its corruption and property rights scores from 1991 (which were in line with current day Nordic scores), this model would predict GDP per capita in excess of $65,000 per capita. Our actual GDP is $48,000 per capita (and that’s actually a positive residual above model prediction of $39,000). It’s likely that the worsening corruption situation in the US has literally robbed us of half of the economic growth over the past two decades.

Anon. November 19, 2012 at 5:19 pm

That’s a useless approach though. What reason do you have to believe that high GDP doesn’t cause a decrease in corruption and not the other way around? Or that corruption simply happens to be correlated to the actual causal variable and is in fact insignificant?

Doug November 19, 2012 at 5:54 pm

If low corruption/property rights (really two sides of the same coin) were caused by high wealth and not a cause of high wealth, then they would be consumption goods, not investment goods.

If they were consumption goods then we’d expect to see high heterogeneity of income elasticity across cultures. If they’re investment goods we’d expect to see pretty uniform income elasticity across cultures. E.g. pork is a consumption good, we see high income elasticity across cultures. Muslim countries hardly consume any more pork as they get wealthier, Latin countries have a middle of the road pork income elasticity, and East Asian countries tend to up pork consumption by a lot as they get wealthier.

In contrast power plants are an investment good. They facilitate production, and for a country to be wealthy a universal perquisite is to have high electricity production capacity. Thus we see that Muslim, Latin and East Asian countries all tend to increase power plant capacity by similar levels for similar increases in wealth.

If you sub-divide the regressions by broad cultural groups you still get uniform coefficients on corruption and property rights when regressed against (log) GDP per capita. Lower levels of corruption and better property rights basically predict similar wealth gains across Muslim, Asian, Latin, African, European and Anglosphere countries. If corruption was a consumption good we’d expect this coefficient to vary heavily since different cultures should have different levels of preferences for low corruption.

In contrast an institutional variable that does behave this way is crime. Income levels are cross-sectionally correlated with crime rates. But when you sub-divide countries by cultural groups you get very different coefficients. The Asian and Muslim countries have very big drops in crime associated with higher income, whereas the African and Latin countries have lower coefficients. That’s a strong indicator that wealth levels primarily cause lower crime, and not vice versa.

Manoel Galdino November 19, 2012 at 6:07 pm

Maybe it’s pretty standard or maybe I’m missing something, but I found the comment by Doug on of the best I’ve ever read here (admittedly I’m not a frequent reader of MR). It seems a very clever way to use theory to separate causal effects.

ad*m November 20, 2012 at 12:54 pm

+1

Great comment indeed! It definitely puts my (majority snarky I now realize) comments to shame.
Tyler, is there a way to ‘escalate’ Doug’s comment so we can argue this back and forth a bit more?

david November 19, 2012 at 6:56 pm

Consumption of, e.g., broadcast media and personal transport surge uniformly with industrialization. Heterogeneity cannot be taken for granted. People can find substitutes for pork, but not clean government.

The single strongest econometric result in all economics is Engel’s law, regarding the

david November 19, 2012 at 7:05 pm

… how the heck did this get posted?

david November 19, 2012 at 7:05 pm

Consumption of, e.g., broadcast media and personal transport surge uniformly with industrialization. Heterogeneity cannot be taken for granted. People can find substitutes for pork, but corruption measures are precisely already designed to suppress variations in policy types.

Between, say, Singapore and New Zealand, tactics for suppressing corruption vary (powerful centralized bureau that report to the executive vs. independent commissions that report to the legislature) and the kinds of things which are perceived as “corrupt” vary – Singapore regards even private sector guanxi as corruption and its CPIB is empowered to suppress it, whereas New Zealand would regard the PAP politburo as functionally corrupt.

Conversely things which are undeniably investment goods are frequently heterogeneous in the data. Think about the income elasticity of snowplows (vs snowshovels), which has an obvious reason why many countries would not invest in these, no matter how rich they get.

Anthony November 19, 2012 at 5:14 pm

Anon at 4:03 has a point – in an over-regulated country, corruption makes substantially more economic activity possible. This is even more true if the bribes are predictable – from the POV of the businessman, it’s just a tax; it doesn’t matter whether the tax collector puts the money into the Treasury or his own pocket.

Doug November 19, 2012 at 6:02 pm

The difference is huge. It basically comes down to the roving vs stationary bandit. Corruption is much more like the former, whereas statutory national taxation is much more like the latter. In general the “taxation” levied by corruption tends to be highly unpredictable and maximally short-term exploitive.

Ask yourself if you were a businessman would you rather open a business in high-tax Finland or in an industry controlled by mobsters (like say Northern Jersey waste management).

david November 19, 2012 at 7:07 pm

Cronyism is frequently heavily entrenched, and far more reliably so than in less-corrupt populist democracies. Not all corruption is made equal.

anonymous... November 19, 2012 at 8:05 pm

Actually, mobsters often levy a quite predictable percentage “tax”, at least if they have undisputed control of a particular industry or turf. Of course problems can arise when there is a changing of the guard or a turf war, when things are in flux.

A worse problem, actually, is a litigious society, where anyone can sue anyone out of the blue. If you pay protection money to a mobster or politician, at least he has a vested interest in preventing anyone else from trying to collect from you. With litigation there is no protection at all; although lawyers filing class action lawsuits do offer some “protection” to the target company in excluding duplicate claims, this is rather inadequate.

Brandon Reinhart November 19, 2012 at 6:47 pm

It’s a +1 to the Marginal Revolution University course on Economic Development that I can follow this post in its entirety.

Jamie_NYC November 19, 2012 at 7:09 pm

Isn’t this the problem with the sample: the extractive economies have both appalling levels of corruption and high rate of growth (think Angola). The natural resources enable the growth, and also make corruption at the highest levels relatively easy.

DocMerlin November 19, 2012 at 7:25 pm

Um, since when is corruption bad?
Corruption isn’t bad it makes good less good and makes bad bearable. High amounts of corruption in an evil regiem would make it less evil. Wouldn’t the world have been a better place, if Hitler and Stalin had been corrupt?

DocMerlin November 19, 2012 at 7:25 pm

I think we all wish that Hitler and Stalin had been more corrupt.

Slugger November 19, 2012 at 7:36 pm

A long time ago I read a science fiction story that postulated that a little bit of corruption was a form of social grease that kept us all from being suffocated by nit-picking idealogues. I believe the author was Harry Harrison.
Life under a ruler who takes a little juice is probably better than under a ruler who demands absolute fealty. Was the US served better by a drinking, womanizing Clinton or a sober straight arrow Bush.

anonymous... November 19, 2012 at 8:27 pm

“Happy families are all alike; every unhappy family is unhappy in its own way.”

Read “countries” for families, with happy = non-corrupt and unhappy = corrupt. In some places corruption greases the gears of the economy, while in others it throws sand into them. If you can’t find examples of the latter, you’re not looking hard enough.

For instance, how many would-be entrepreneurs in Russia are held back by the fact that the mafia and the government (there is not always a clear distinction) simply send in the masky-show cops to take over successful small companies overnight, lock stock and barrel? How many would-be entrepreneurs in Mexico are held back by the fact their extended families would become targets for kidnapping?

There have been cases of Mexicans in Silicon Valley reluctantly having to turn down venture capital, because word would inevitably get out, and bringing the entire extended family to the US is a pipe dream, especially post 9-11. This is the sort of thing that alters the entire course of someone’s life.

Willitts November 19, 2012 at 9:34 pm

Sorry, but saying that economic development is associated with sexual harassment if only because more women are in the workplace is like saying economic development leads to more toilets in office buildings being clogged by sanitary napkins.

I don’t mean to diminish the effect of harassment or say women shouldn’t be in thr workplace. Im just saying this is not a meaningful economic insight. Unless you’re counting the gains and losses from lawsuits in which case I believe a few windows are being broken. Clogged toilets are a very real negative.

Next you’ll tell us that emancipation of slaves results in more civil rights violations.

Bill Champ November 20, 2012 at 9:32 am

A year ago I also wondered how corruption and prosperity might be related. I graphed GDP per capita against the Corruption Perception Index compiled by Transparency International. This showed a substantial relationship. See my graph here: http://mychamp.com/Corruption%20v.%20GDP.pdf

Todd Ramsey November 20, 2012 at 10:16 am

Government provides an essential service: the protection of private individuals and their property. When individuals believe their property is well-protected, they confidently go about the activities that produce economic growth: innovation, trade, investment, education, and standardization. The less certainty they have about how well their property is protected, the less they will go about the ITIES activities, and the less economic growth will occur.

Corruption reduces the certainty individuals have about the protection of their property, because there are no clear-cut rules about the cost and effectiveness of the government protection.

Furthermore, the resources transferred to the government, or to corrupt government employees, are resources not available to the ITIES activities that allow economic growth.

Economic growth depends on three factors with regards to corruption: the reliability of private property protection; the cost of that protection; and the certainty of the projected future changes in that cost. Corruption interferes with all three of these factors and is therefore a hindrance to economic growth.

Mr. Tuxedo November 22, 2012 at 10:13 pm

Read the book “Why Nations Fail” and you may have some new conclusions.

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