The impact of corruption on development and economic performance

Table of Content

1. Introduction

2. Definition of corruption

3. The impact of corruption on development and economic performance ...

4. The impact of corruption on growth

5. The channels of transmission
5.1. The impact of corruption on private investment
5.2. The impact of corruption on public expenditure
5.3. The impact of corruption on the human capital accumulation
5.4. The impact of corruption on productivity

6. Conclusion

7. List of References

1. Introduction

During the last decades, corruption became an important topic on many national as well as on the international agenda. About twenty years ago the issue started to gain increasing attention. Organizations like the United Nations, the Organization of American States, the International Chamber of Commerce, Transparency International and also the Organization for Economic Cooperation and Development all engage in the fight against corruption (Glynn et al., 1997: 8). This is a remarkable change compared to the situation before the 1990s. Back then, most people did not see it as a pressing problem. Actually, it was more seen as an integral part of doing business. Most European countries allowed for tax deductibility of bribes. Even the World Bank, not constricted by such national concerns, was avoiding the topic (Galtung, 2000: 19ff).

The changed perception of corruption has manifold reasons. Foremost, the geopolitical situation changed remarkably. During the cold war, governments, despite their corruptness, were supported to make sure they were not joining the communist bloc. After the end of this ideological competition, the imperative to tolerate and not to address issues like corruption and abuse of political power ceased to exist. Further, in a variety of countries the citizens aspired against repressive governments and a freer press unveiled corruption scandals around the world. Last, but not less important, the USA, not constraint by geopolitical considerations, had economic interest to put the topic on the agenda. While for US-companies bribing abroad was forbidden, most other developed countries used graft to initiate business abroad. Therefore, the US had a special interest to push for anti-corruption laws to level the playing field for its companies (Galtung, 2000: 21f).

From a western normative and moral point of view this fight against corruption on the international level seems to be a desirable development. However, if those were the only reasons for this crusade, it could be misperceived as another example of the imposition of rules from the Global North on the Global South. Then again, if corruption has negative impacts, other than moral concerns, it would legitimize this movement. Prevailing corruption might influence the development and economic performance of a country. In today's perception development and economic performance includes a variety of indicators, such as a country's Gross Domestic Product (GDP), a fair income distribution, environmental safety, good institutions and all other fields that improve people's quality of life.

Therefore, after having narrowed the definition of corruption as it is understood within this paper, the correlation between corruption and some of these indicators will be examined. After this basic assessment, the relationship between economic growth, as one of the indicators for development, and corruption shall be illuminated closer. The question, whether there is a causal relationship and what the channels of this connection are shall be explored. Eventually, the insights gathered in this paper will be summarized and a conclusion will be drawn.

2. Definition of corruption

In the literature one can find a variety of definitions for corruption, some divide the term in different types of corruption and some use a really broad definition. In most of them the role of the state is included and corruption is described as some kind of a perverted state-society relationship. It is normally understood as the exploitation of public resources and entrusted power by a public official for private gains. The definition used by the World Bank, Transparency International and also some other institutions describes corruption as "the abuse of public power for private benefit (or profit)" (Andwig et al., 2000: 11). This shall be the understanding of corruption within the framework of this paper.

3. The impact of corruption on development and economic performance

A first idea whether there is a relationship between development and corruption can be seen, if one looks at the figures 1-4. Here the Corruption Perception Index¹ (CPI) is plotted against a variety of indicators for development.

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Figure 1-4: Correlation between Corruption and GDP per capita/Gini-Coefficient/Expenses for Education/Life Expectation (own illustration. Data retrieved from (Central Intelligence Agency, 2009) and (Transparency International, 2009))

The upper left graph shows a clear correlation between a high level of GDP and a low level of corruption. Likewise, the other graphs show that in countries with low levels of corruption income inequality, as measured by the Gini- Coefficient, is in general lower and that countries with low corruption invest more in education. Also life expectancy is generally lower in countries with high levels of corruption. Hence, if one accepts those indicators as a rough picture of the state of development of a country, it becomes clear that there is a negative correlation between the level of corruption and the level of development in a country. Nonetheless, those graphs say nothing about the causality of this relationship. Is it due to their high level of corruption that some countries develop slower than others, or do less developed countries just lack the resources to fight corruption efficiently? Both explanations are possible. Maybe none of them is true and it is just a spurious correlation and the explaining factors lay somewhere else. Consequently, without an in-depth analysis of those relations, no clear conclusion can be drawn. Therefore, the following part of this paper will analyze one of those relations, namely the relationship between GDP-growth and corruption.

4. The impact of corruption on growth

Corruption could impact growth in manifold ways. Some theories predict that corruption enhances efficiency and has a positive impact on economic growth. Here, bribes are seen as a tool to "grease the wheels". To arrive at this conclusion, a second best world is assumed. Government regulations are seen as ineffective and administrative processes as slowing down economic activity. Some researchers have shown in theoretical models that graft can speed up the processes in else sluggish institutions. Further, the possibility of collecting bribes may be seen as additional payment to government servants. Hence, some able workers that would otherwise opt for another career may apply for a government position and therefore, overall productivity of government services is increased. Likewise, bribes could work similar as piece rate wages and therefore, increase the efficiency of civil servants. Further, if a government is discriminating against minorities or has a negative attitude towards entrepreneurship, corruption might limit the negative consequences of such inefficient regulations. Nonetheless, those possible positive effect of corruption only occur, when there is already an inefficiency, namely a defective government (Meon and Weill, 2008: 4f). Looking at corruption from a more dynamic perspective the positive effect of corruption on growth can be dispelled. Kaufmann observed that government officials have an enormous amount of discretion about the creation, proliferation and interpretation of regulations and laws. The possibility of getting bribed for helping people to get around certain regulations, may act therefore as an incentive to enact more regulations to increase the amount of bribes. Hence, corruption, seen over time, can add to the amount of governmental hurdles for business and therefore might damage growth (Kaufmann, 1997: 115). Besides those theoretical considerations, looking at the empirical figures one has to doubt the positive link between growth and corruption. Figure 5 is looking at a correlation between a corrected measure of growth in the period of 1975 - 1996 and the average CPI-Index of a country in the period 1980 - 1985. Here one can clearly see that corruption is negatively correlated with growth.

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Figure 5: Growth rate of per capita income, in the period 1975-96, versus corruption, in the period 1980-85. Growth rates are corrected for initial income effect (Source: (Gerlagh and Pellegrini, 2004: 435))

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¹ This CPI-score indicates the perceived level of public sector corruption in a country, a higher rank indicates lower levels of perceived corruption (Transparency International, 2009).