Government Corruption

Over the last few years, the issue of corruption--the abuse of public office for private gain--has attracted renewed interest, both among academics and policymakers. There are a number of reasons why this topic has come under recent inspection. Corruption scandals have toppled governments in both major industrial countries and developing countries. In the transition countries, the shift from command economies to free market economies has created massive opportunities for the appropriation of rents, excessive profits, and has often been accompanied by a change from a well-organized system of corruption to a more chaotic and deleterious one. With the end of the cold war, donor countries have placed less emphasis on political considerations in allocating foreign aid among developing countries and have paid more attention to cases in which aid funds have been misused and have not reached the poor. And slow economic growth has persisted in many countries with malfunctioning institutions. This renewed interest has led to a new flurry of empirical research on the causes and consequences of corruption.

Economists know quite a bit about the causes and consequences of corruption. An important body of knowledge was acquired through theoretical research done in the 1970s by Jagdish Bhagwati, Anne Krueger, and Susan Rose-Ackerman, among others. A key principle is that corruption can occur where rents exist--typically, as a result of government regulation--and public officials have discretion in allocating them. The classic example of a government restriction resulting in rents and rent-seeking behavior is that of an import quota and the associated licenses that civil servants give to those entrepreneurs willing to pay bribes.

More recently, researchers have begun to test some of these long-established theoretical hypotheses using new cross-country data. Indices produced by private rating agencies grade countries on their levels of corruption, typically using the replies to standardized questionnaires by consultants living in those countries. The replies are subjective, but the correlation between indices produced by different rating agencies is very high, suggesting that most observers more or less agree on how corrupt countries seem to be. The high prices paid to the rating agencies by their customers (usually multinational companies and international banks) constitute indirect evidence that the information is valuable. These indices are obviously imperfect owing to their subjective nature, but can yield useful insights.

Since the ultimate source of rent-seeking behavior is the availability of rents, corruption is likely to occur where restrictions and government intervention lead to the presence of such excessive profits. Examples include trade restrictions such as tariffs and import quotas, industrial policies such as subsidies and tax deductions, price controls, multiple exchange rate practices and foreign exchange allocation schemes, and government-controlled provision of credit. Some rents may arise in the absence of government intervention, as in the case of natural resources, such as oil, whose supply is limited by nature and whose extraction cost is far lower than its market price. Since abnormal profits are available to those who extract oil, officials who allocate extraction rights are likely to be offered bribes. Finally, one would expect that corruption is more likely to take place when civil servants are paid very low wages and often must resort to collecting bribes in order to feed their families.

While all of the hypotheses described above are empirically testable, in the sense that data are available for that purpose, only a few have actually been tested. What empirical studies have been done support certain hypotheses: namely, that there is less corruption where there are fewer trade restrictions; where governments do not engage in favoritist industrial policies; and perhaps where natural resources are more abundant; and that there is somewhat less corruption where civil servants are paid better, compared with similarly qualified workers in the private sector.

From economic theory, one would expect corruption to reduce economic growth by lowering incentives to invest. In cases where entrepreneurs are asked for bribes before enterprises can be started, or corrupt officials later request shares in the proceeds of their investments, corruption acts as a tax, though one of a particularly pernicious nature, given the need for secrecy and the uncertainty as to whether bribe takers will live up to their part