Question

How would you explain the correlation between the amount of corruption in a country and economic development? Answer should be at least 250-300 words. No hand written Post.

Answer 1

Through an investigation of the relationship between corruption and anticorruption measures on the one hand, and economic performance on the other, and an analysis of the manifold channels through which this relationship operates, this paper offers a better understanding of the complex factors constraining the economic potential of countries affected by this phenomenon. Indeed, it demonstrates that, while the direct link between corruption and GDP growth is difficult to assess, corruption does have significant negative effects on a host of key transmission channels, such as investment (including FDI), competition, entrepreneurship, government efficiency, including with regards to government expenditures and revenues, and human capital formation. Furthermore, corruption affects other important indicators of economic development such as the quality of the environment, personal health and safety status, equity (income distribution), and various types of social or civic capital (“trust”) - which impact significantly on economic welfare and, in the case of a trust, also a country’s development potential. The G20 agenda on anti-corruption as laid out in the 2010 and 2012-2013 Anticorruption Action Plans addresses many of the challenges related to the transmission channels. Tackling domestic and foreign bribery and building transparent and accountable public institutions helps enhance investment and competition and promotes public sector integrity, government efficiency, and entrepreneurship. Further analysis and research at the country level would establish where and how corruption is hurting economic performance, and how the objectives of policy measures and reforms may be more clearly defined. This would also address the difficulty of assessing progress and ascertaining the impact of anti-corruption policies – which is currently an obstacle to more decisive, coherent and sustained action in this field in many countries.

The strong negative correlation between perceived corruption and the level of output provides prima facie evidence of the negative impact corruption has on value creation. While the causality underlying this relationship is likely to run both ways, the majority of analysts agree that it is primarily running from corruption to output rather than in the opposite direction. Still, the two-way relationship has the potential of setting in motion a virtuous circle, where output gains from curtailing corruption can be invested in human and civic capital necessary to make further progress in reducing corruption, leading to more output gains, and so forth. The strong correlation between the levels of output and perceived corruption does not establish a direct causal relationship. A major reason why this is so is the fact that corruption indicators tend to be highly correlated with other public sector governance indicators, like the rule of law, government effectiveness, and regulatory quality. Consequently, the corruption impact on output observed in empirical analysis tends to also capture some of the beneficial effects of good governance in general, if the pertinent indicators are not included in the analysis. This is indeed confirmed by the fact that the estimated effects of corruption on output tend to change in both size and significance if other governance indicators are included in the analysis. The true social cost of corruption cannot be measured by the amount of bribes paid or even the amount of state property stolen. Rather, it is the loss of output due to the misallocation of resources, distortions of incentives and other inefficiencies caused by corruption that represent its real cost to society. And in addition to these output losses, corruption can inflict additional welfare costs in terms of adverse effects on the distribution of income and disregard for environmental protection. Most importantly, corruption undermines public trust in the government, thereby diminishing its ability to fulfill its core task of providing adequate public services and a conducive environment for private sector development. In extreme cases, it may entail the delegitimization of the state, leading to severe political and economic instability. The resulting general uncertainty is detrimental to private business’ willingness and ability to commit to a long-term development strategy, lack of which makes sustainable development hard to achieve.

In contrast to the strong correlation between perceived corruption and output levels, the correlation between perceived corruption and GDP growth is weak. There are a number of possible reasons for the low correlation between these two variables: the linkages are likely to be complicated, indirect, time variant, and non-linear. And it is indeed conceivable that corruption actually facilitates growth in situations where prevailing government regulations are growth-impeding. Analysis of such situations reveals, however, that they always represent second- (or third-) best scenarios, and that removing the regulatory impediments to growth is better than circumventing them by corruption. Similarly, where “close and intimate” links between public sector officials and leaders of industry (aka “crony capitalism”) are claimed to facilitate rapid growth, an explicit and transparent industrial policy should be capable of achieving similar or superior results, without the damaging secrecy and unfairness that crony capitalism necessarily implies. These findings support continuing policies that strengthen accountability and enforce transparency in order to achieve sustainable economic growth. Corruption may not affect output directly but operates through different transmission channels that have been studied extensively. They include (indirect) corruption effects on both output levels and growth rates. The most thoroughly studied transmission channel is a private investment: by reducing its profitability and increasing uncertainty, corruption will tend to depress the level of business investment. This applies a fortiori to the sub-category of foreign direct investment, which is a major vehicle of technology transfer. These effects will, in turn, reduce the attractiveness of entrepreneurship, diverting entrepreneurial talent to less productive activities, which will negatively impact the pace of innovation and thus economic growth.