The Effects of Corruption On Growth, Investment, and Government Expenditure: A Cross-Country Analysis

"
83
The LIIecIs oI 0orrupI|on on 6rowIh,
InvesImenI, and 6overnmenI Lxpend|Iure:
k 0ross-0ounIry kna|ys|s
2) )74
The sludy of lhe causes and consequences of corruplion has a long
hislory in economics, daling back al leasl lo lhe seminal conlribulions lo
lhe renl-seeking lileralure by hagvali (1982), Krueger (1974), Rose-
Ackerman (1978), Tullock (1967), and olhers. Hovever, empirical vork
in lhis area has been limiled, parlly because lhe efficiency of govern-
menl inslilulions cannol easily be quanlified. Corruplion in parlicular is
by ils very nalure difficull lo measure.
Reneved inleresl in lhe lopic has led a number of researchers lo
allempl lo quanlify, using regression analysis and indices developed by
privale raling agencies, lhe exlenl lo vhich corruplion permeales eco-
nomic inleraclions. These indices are lypically based on replies lo
slandardized queslionnaires by consullanls in a variely of counlries and
lherefore have lhe obvious dravback of being sub|eclive. Neverlheless,
lhe correlalion belveen indices produced by differenl raling agencies is
very high, suggesling a cerlain consensus on lhe ranking of counlries
according lo lheir degree of corruplion. In addilion, lhe high prices lhal
lhe raling agencies charge lheir cuslomers (usually mullinalional com-
panies and inlernalional banks) for access lo lhese indices are indirecl
evidence lhal lhe informalion is useful.
Al lhe same lime, hovever, lhe consullanls |udgmenls lhal form lhe
basis of lhese indices may be influenced by lhe economic performance
of lhe counlries lhey monilor. Thus, researchers vho use such indices
musl be exlremely caulious in asserling a causal relalionship belveen
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Institute for International Economics | http://www.iie.com
84 COPPUPTlON AND THE CLOBAL ECONOMY
uilding upon lheorelical conlribulions from lhe lileralure on renl-seek-
ing behavior, recenl empirical sludies analyze lhe possible causes of
0auses oI 0orrupI|on
corruplion and any economic variables found correlaled vilh il. ne
vay of addressing lhis possible endogeneily problem is lhrough lhe use
of inslrumenlal variables, as discussed laler in lhis chapler.
An addilional dravback of currenlly available indicalors of corruplion
is lheir generalily: lhey do nol dislinguish, for example, belveen high-
level corruplion (such as kickbacks lo a defense minisler for lhe pur-
chase of expensive |el fighler aircrafl) and lov-level corruplion (such as
lhal of a minor official accepling a bribe lo expedile issuance of a drivers
license). Nor do lhey dislinguish belveen vell-organized and poorly
organized corruplion. In lhe laller, lhe required amounl and appropri-
ale recipienl of a bribe are lefl unclear, and paymenl does nol guaran-
lee lhal lhe desired favor vill be oblained. The uncerlainly of poorly
organized syslems of corruplion may make lhem lhe more harmful of
lhe lvo (Shleifer and Vishny 1993). Yel, even vilh lhese limilalions, lhe
indices provide a veallh of informalion from vhich researchers have
oblained a number of inleresling resulls.
This chapler idenlifies a number of possible causes and consequences
of corruplion, vilh emphasis on lhose links lhal have been or lhal could,
al leasl in principle, be invesligaled lhrough lhe use of cross-counlry
regression analysis. The chapler revievs and synlhesizes lhe resulls of
recenl sludies lhal have made use of such regressions. Allhough dala
limilalions sub|ecl lhe empirical vork lo a number of difficullies, lhese
sludies provide lenlalive evidence lhal corruplion may have considerable
adverse effecls on economic performance lhal meril lhe allenlion of
policymakers. More inlereslingly, lhe idenlificalion of possible causes of
corruplion may suggesl a number of vays lo curb il. Allhough in some
cases lhe dislinclion belveen causes and consequences is blurred, lhere
are cases vhere such ambiguilies aboul lhe direclion of causalily should
nol be overslaled in draving policy conclusions, as argued belov.
This chapler also presenls nev resulls on lhe effecls of corruplion on
inveslmenl and economic grovlh. These resulls vere oblained by using
a larger dala sel lo expand lhe analysis of Mauro (1995). Nev evidence
is also presenled on lhe relalionship belveen corruplion and lhe compo-
silion of governmenl expendilure. These resulls need lo be inlerpreled
vilh caulion, bul lhey do indicale lhal corruplion lovers overall invesl-
menl and economic grovlh and allers lhe composilion of governmenl
expendilure, specifically by reducing lhe share of spending on educalion.
Causes and Consequences of Corruption
A CPOSS-COUNTPY ANALYSlS 86
corruplion by regressing indices of corruplion on a number of polenlial
explanalory variables. Several of lhese causal variables are relaled lo lhe
exlenl of governmenl inlervenlion in lhe economy and, more generally,
lo variables (such as lhe level of imporl lariffs or civil service vages)
lhal are delermined by gctcrnmcnt pc|ic. Where regulalions are perva-
sive and governmenl officials have vide discrelion in applying lhem,
privale parlies may be villing lo pay bribes lo governmenl officials lo
oblain any renls lhal lhe regulalions may generale. Idenlifying such
policy-induced sources of corruplion is obviously helpful in bringing il
under conlrol. The folloving paragraphs lisl some of lhe sources of cor-
ruplion idenlified in lhe lileralure.
The original lileralure on renl seeking emphasizes lrade reslriclions
as lhe prime example of governmenl-induced sources of renls (Krueger
1974). Ior example, quanlilalive reslriclions on imporls make lhe neces-
sary imporl licenses very valuable, imporlers may lhen be villing lo
bribe lhe relevanl officials in order lo oblain lhem. More generally, pro-
leclion of domeslic induslries from inlernalional compelilion generales
renls lhal local enlrepreneurs may be villing lo pay for, in lhe form of
bribes. Ades and Di Tella (1994) find lhal grealer openness in an economy,
as measured by lhe sum of imporls and exporls as a share of CDI, is
significanlly associaled vilh lover corruplion.
Covernmenl subsidies can be a source of renls, as Clemenls, Hugounenq,
and Schvarlz (1995) have argued. Ades and Di Tella (1995) explain cor-
ruplion as a funclion of industric| pc|ic, shoving lhal subsidies lo
manufacluring (measured as a proporlion of CDI) are correlaled vilh
corruplion indices.
1
Irice conlrols (vhich can be quanlified on lhe basis of indicalors such
as lhose in World ank 1983) are also a polenlial source of renls and
lherefore of renl-seeking behavior. Ior example, enlrepreneurs may be
villing lo bribe governmenl officials lo mainlain lhe provision of inpuls
al belov-markel prices.
Similarly, mulliple exchange rale syslems and foreign exchange allo-
calion schemes (vhose imporlance may be proxied by parallel exchange
markel premiums, such as lhose used by Levine and Renell |1992]) lead
lo renls. Ior example, suppose lhal, in a given counlry, managers of
slale-ovned commercial banks ralion foreign exchange according lo pri-
orilies lhey lhemselves eslablish, lhen lhe counlrys enlrepreneurs may
be villing lo bribe lhe managers lo oblain lhe foreign exchange neces-
sary lo purchase imporled inpuls.
Lov vages in lhe civil service relalive lo privale-seclor vages or CDI
per capila are also a polenlial source of (lov-level) corruplion, folloving
1. Ades and Di Tella (1995) also argue lhal, in evalualing lhe cosls and benefils of indus-
lrial policies, il is necessary lo lake inlo accounl lhe facl lhal lhey may generale corrup-
lion as an uninlended byproducl.
efficiency-vage mechanisms (Kraay and Van Ri|ckeghem 1995, Haque
and Sahay 1996). Thal is, vhen civil servanls are nol paid enough lo
make ends meel, lhey may be obliged lo use lheir posilions lo collecl
bribes, especially vhen lhe expecled cosl of being caughl and fired is
lov. Counlries should lake such consideralions inlo accounl vhen faced
vilh lhe difficull choice of lovering an excessive civil service vage
bill by culling salaries or by reducing lhe number of slaff. The Inler-
nalional Monelary Iunds Iiscal Affairs Deparlmenl (1995, 15) varns of
lhe dangers of across-lhe-board civil service vage culs, vhich could lead
lo a rise in corrupl behavior.
lher sources of renls or faclors lhal make il more likely lhal renls
vill be exploiled are due nol lo governmenl policy bul lo cerlain under-
lying characlerislics of an economy or a sociely. Iolicymakers need lo
be alerl lo lhe possibilily of renl-seeking behavior arising from lhese
faclors, and allempls lo evaluale lhe effecls of governmenl policy on
corruplion need lo lake lhem inlo accounl as vell. The folloving are
some of lhese nongovernmenlal causes of corruplion.
Nalural-resource endovmenls are a lexlbook example of a source of
renls, since lhese resources can lypically be sold al a price far exceeding
lheir cosl of exlraclion. Sachs and Warner (1995) argue lhal resource-rich
economies may be more prone lhan resource-poor economies lo exlreme
renl-seeking behavior. They find (allhough nol al convenlional levels of
slalislical significance) lhal a counlrys share of primary-producl exporls
in lolal exporls is associaled vilh indices of bureaucralic efficiency.
Sociological faclors may conlribule lo crealing an environmenl in
vhich lhe availabilily of renls is more likely lo resull in renl-seeking
behavior. Shleifer and Vishny (1993) suggesl lhal in counlries populaled
by several elhnic groups one is more likely lo find a less organized-and
lherefore polenlially more harmful-lype of corruplion. This hypolhesis
is used in Mauro (1995), vhere an index of elhnolinguislic fraclionaliza-
lion is found lo be correlaled vilh corruplion. Tanzi (1994) argues lhal
public officials are more likely lo do favors for friends and relalives in
socielies in vhich relalionships are more personalized.
0onseguences oI 0orrupI|on
Corruplion has a number of adverse consequences. In parlicular, recenl
empirical evidence suggesls lhal corruplion lovers economic grovlh.
This may happen lhrough any of a vide range of channels.
Where corruplion exisls, enlrepreneurs are avare lhal some of lhe
proceeds from lheir fulure inveslmenls may be claimed by corrupl offi-
cials. Iaymenl of bribes is oflen required before necessary permils vill
be issued. Therefore, inveslors may perceive corruplion as a lax-and
one of a parlicularly pernicious nalure, given lhe need for secrecy and
lhe uncerlainly lhal come vilh il-vhich reduces incenlives lo invesl.
Mauro (1995) provides lenlalive empirical evidence lhal corruplion
lovers inveslmenl and economic grovlh. The observed effecls are con-
siderable in magnilude: in an analysis using lhe usiness Inlernalional
(I) indices of corruplion, a one-slandard-devialion improvemenl in lhe
corruplion index causes inveslmenl lo rise by 5 percenl of CDI and lhe
annual rale of grovlh of CDI per capila lo rise by half a percenlage
poinl. The evidence indicales lhal much of lhe effecls on economic grovlh
lake place lhrough lhe effecls on inveslmenl. Using indices of inslilu-
lional efficiency from lhe Intcrncticnc| Ccuntr Ris| Guidc (ICRG), Keefer
and Knack (1995) oblain broadly similar resulls, and in lheir eslimales
inslilulional variables have a significanl direcl effecl on grovlh in addi-
lion lo lhe indirecl effecl lhrough inveslmenl.
2
Iurlher evidence on lhese
relalionships is presenled belov.
Murphy, Shleifer, and Vishny (1991) argue lhal in silualions vhere renl
seeking provides more lucralive opporlunilies lhan produclive vork does,
lhe allocalion of lalenl vill be vorse: lalenled and highly educaled in-
dividuals vill be more likely lo engage in renl seeking lhan in produclive
vork, vilh adverse consequences for lheir counlrys grovlh rale.
f parlicular relevance lo developing counlries is lhe possibilily lhal
corruplion mighl reduce lhe effecliveness of aid flovs, lhrough lhe di-
version of funds from lheir inlended pro|ecls. The vasl lileralure on aid
flovs has explored vhelher lhe fungibilily of aid resources ullimalely
resulls in aid flovs financing unproduclive public expendilures. Ierhaps
as a resull of lhis ongoing debale, many donor counlries have focused
increasingly on issues of good governance, and in some cases in vhich
governance is |udged lo be very poor, some donors have scaled back
lheir assislance (IMI 1995, 32-34).
Corruplion may also bring aboul loss of lax revenue vhen il lakes
lhe form of lax evasion or lhe improper use of discrelionary lax exemp-
lions. Slriclly speaking, lhese phenomena fall under lhe definilion of
corruplion only vhen lhere is a counlerparl paymenl lo lhe lax official
responsible.
y affecling lax colleclion or lhe level of public expendilure, corrup-
lion may have adverse budgelary consequences. Allernalively, vhere
corruplion lakes lhe form of lhe improper use of direcled lending al
belov-markel inleresl rales by public-seclor financial inslilulions, cor-
ruplion may resull in an undesirably lax monelary slance.
The allocalion of public procuremenl conlracls lhrough a corrupl sys-
lem may lead lo inferior public infraslruclure and services. Ior example,
corrupl bureaucrals mighl allov lhe use of cheap, subslandard malerials
in lhe conslruclion of buildings or bridges.
2. ne vay in vhich lhe grovlh rale may be affecled even for a given inveslmenl rale
is lhrough changes in lhe allocalion of resources among seclors (Laslerly 1990), perhaps
including lhal belveen lhe formal and lhe informal seclors (Loayza 1996).
Iinally, corruplion may affecl lhe composilion of governmenl expen-
dilure. Il is lhis possibilily on vhich lhe empirical seclion of lhis chapler
focuses. Corrupl governmenl officials may come lo prefer lhose lypes of
expendilure lhal allov lhem lo collecl bribes and lo keep lhem secrel.
Shleifer and Vishny (1993) suggesl lhal large expendilures on special-
ized ilems such as missiles and bridges, vhose exacl markel value is
difficull lo delermine-lead lo more lucralive opporlunilies for corrup-
lion. pporlunilies for levying bribes may also be more abundanl in
conneclion vilh ilems produced by firms operaling in oligopolislic mar-
kels, vhere renls are available. ne mighl expecl a priori lhal subslan-
lial bribes are easier lo collecl on large infraslruclure pro|ecls or high-
lechnology defense equipmenl lhan on lexlbooks and leachers salaries.
Ior example, Hines (1995) argues lhal inlernalional lrade in aircrafl is
parlicularly susceplible lo corruplion. In olher areas, such as heallh, lhe
piclure is less clear-cul: opporlunilies lo collecl bribes may be abundanl
in lhe procuremenl of hospilal buildings and slale-of-lhe-arl medical
equipmenl bul more limiled in lhe paymenl of doclors and nurses
salaries.
Lmpirical vork on lhe polenlial links belveen corruplion and lhe
composilion of governmenl expendilure is exlremely limiled. Among lhe
fev conlribulions, Rauch (1995) analyzes bolh lhe delerminanls and lhe
effecls of governmenl expendilure composilion in a sample of US cilies.
He finds lhal lhe vave of municipal reform during lhe Irogressive Lra
increased lhe share of lolal municipal expendilure allocaled lo road and
sever inveslmenl, vhich in lurn increased grovlh in manufacluring em-
ploymenl in lhose cilies. To probe furlher inlo lhis relalively unexplored
issue, lhis chapler analyzes dala from a cross-seclion of counlries and
finds lenlalive evidence lhal corruplion may lover governmenl spend-
ing on educalion as a proporlion of CDI.
EmpiricaI AnaIyses
This chapler uses indices of corruplion dravn from lvo privale firms:
Iolilical Risk Services, Inc., vhich publishes lhe Intcrncticnc| Ccuntr Ris|
Guidc (ICRG), and usiness Inlernalional (I, nov incorporaled inlo lhe
Lccncmist Intc||igcncc Unit).
The ICRG indices are described in delail by Keefer and Knack (1995).
The index used here, vhich vas compiled by lhe IRIS Cenler al lhe
Universily of Maryland, is lhe 1982-95 average from lhe ICRG and is
available for more lhan a hundred counlries. This index purporls lo
measure for each counlry lhe likelihood lhal high governmenl officials
|vill] demand special paymenls and lhal illegal paymenls are gener-
escr|pI|on oI Ihe aIa
ally expecled lhroughoul lover levels of governmenl in lhe allocalion
of imporl and exporl licenses, foreign exchange, lax assessmenls, credil,
and lhe like (Keefer and Knack 1995, 23).
The full I dala sel used in lhis chapler is provided, logelher vilh a
more complele descriplion, in Mauro (1995). The index used is lhe 1980-
83 average and is available for 67 counlries. This index allempls lo
measure lhe degree lo vhich business lransaclions involve corruplion
or queslionable paymenls (Mauro 1995, 684). olh lhe ICRG and lhe I
indices are scaled from 0 (mosl corrupl) lo 10 (leasl corrupl), vilh simi-
lar dislribulions.
The corruplion index used in lhis chapler is lhe simple average of
lhe ICRG and I indices, vhen bolh are available, and lhe ICRG index
olhervise. The lvo indices are slrongly correlaled (r ~ 0.81) and, argu-
ably, averaging lhem may reduce lhe errors in each. There are lhus 106
observalions in lhe arro (1991) sample for vhich lhe corruplion index
is available. The sample slalislics are as follovs: mean ~ 5.85, slandard
devialion ~ 2.38, minimum ~ 0.59, maximum ~ 10.
n lhe argumenl lhal economic grovlh mighl conlribule lo improved
inslilulional efficiency, I use inslrumenlal variables in some eslimales in
lhis chapler lo address polenlial endogeneily bias. The firsl of lhese, an
index of elhnolinguislic fraclionalizalion,
3
is a useful inslrumenl because,
as Shleifer and Vishny (1993) argue, more fraclionalized counlries lend
lo have more dishonesl bureaucracies. The index correlales vell (r ~
0.39, significanl al convenlional levels) vilh lhe corruplion index. The
olher inslrumenls are lvo dummy variables specified lo represenl vhelher
(folloving Taylor and Hudson 1972) lhe counlry has been a colony (since
1776) and vhelher lhe counlry achieved independence afler 1945. These
colonial dummies (dala for vhich come from lhe Lncc|cpcdic 6ritcn-
nicc) are good inslrumenls because lhey, loo, are highly correlaled
vilh a counlrys corruplion index (r ~ 0.46 and 0.38, respeclively, bolh
values are significanl). In addilion, lhese lhree variables may be valid
inslrumenls lo lhe exlenl lhal elhnolinguislic fraclionalizalion and
colonial hislory are unrelaled lo economic grovlh, inveslmenl, or
3. The rav dala from vhich lhis index is conslrucled refer lo 1960 and come from lhe
At|cs |crcdct Mirc (Deparlmenl of Ceodesy and Carlography of lhe Slale Ceological
Commillee of lhe USSR, Moscov, 1964). This publicalion vas lhe resull of a vasl pro|ecl
lo provide an exlremely accurale depiclion of lhe elhnolinguislic composilion of vorld
populalion. The index is compuled by Taylor and Hudson (1972) as
LLl ~ 1 -
S

n
i

2
, i ~ 1, . . . I
vhere n
i
is lhe number of people in lhe ilh group, | is lhe lolal populalion, and I is lhe
number of elhnolinguislic groups in lhe counlry. The index measures lhe probabilily
lhal lvo randomly selecled persons from a given counlry vill nol belong lo lhe same
elhnolinguislic group.
I
|
i ~ 1
lhe composilion of governmenl expendilure, olher lhan lhrough lheir
effecls on corruplion.
This chapler uses lhree slandard sources of dala on lhe composilion
of governmenl expendilure: arro (1991), Devara|an, Svaroop, and Zou
(1993), and Laslerly and Rebelo (1993).
The arro (1991) dala sel conlains 1970-85 averages of governmenl
spending on defense, educalion, social securily and velfare, public
inveslmenl, and lolal governmenl expendilure for over 100 counlries.
The primary sources are lhe Inlernalional Monelary Iunds Gctcrn-
mcnt lincncc Stctistics (GlS) and UNLSC. All macroeconomic vari-
ables are also dravn from arro (1991), since his dala sel provided lhe
basis for much recenl empirical vork on lhe delerminanls of economic
grovlh.
Dala for lhe induslrial counlries vere added lo lhe Devara|an, Svaroop,
and Zou (1993) dala sel of developing counlries lo oblain a larger sample
of around 95 counlries. The dala ullimalely come from lhe GlS and
refer lo 1985. The componenls of expendilure on educalion (primary
and secondary, universily, and olher educalion) and heallh (hospilals,
clinics, and olher) are available for aboul 60 counlries.
The Laslerly and Rebelo (1993) dala sel consolidales lhe public invesl-
menl expendilures of lhe general governmenl vilh lhose underlaken
by public enlerprises for 96 counlries. Il provides dala on lhe com-
posilion of public inveslmenl by seclor (agricullure, educalion, heallh,
housing and urban infraslruclure, lransporl and communicalion, and
induslry and mining) for a sample of aboul 40 developing counlries.
Iublic inveslmenl dala are also available by level of governmenl (gen-
eral governmenl versus public enlerprises) for aboul 50 counlries. The
primary sources are lhe World anks counlry reporls, Uniled Nalions
nalional accounls dala, and lhe World anks annual Wcr|d Dctc|cpmcnt
Rcpcrt.
The LIIecIs oI 0orrupI|on on InvesImenI and Lconom|c 6rowIh
Using cross-counlry regressions similar lo lhose in Mauro (1995), lhis
seclion examines a larger dala sel lo provide furlher evidence lhal cor-
ruplion may affecl inveslmenl and economic grovlh.
4
Regression of lhe
1960-85 average inveslmenl rale alone on lhe corruplion index shovs
an associalion belveen lhese variables lhal is significanl al convenlional
levels (lable 1, column 1). A univariale regression of lhe 1960-85 average
4. The analysis in lhis chapler relies only on cross-seclional regressions using averages of
lhe dala over lhe sample period, as a counlrys degree of inslilulional efficiency lypically
evolves only ralher slovly. Mauro (1993) shovs lhal lhe relalionship belveen invesl-
menl and corruplion is significanl in a fixed-effecls panel.
Table 1 Results of regressions estimating the effects of corruption
on investment-GDP ratios
a
Independent variable Univariate, Univariate, Multivariate, Multivariate,
OLS 2SLS OLS 2SLS
(1) (2) (3) (4)
Constant 0.0780 0.0025 0.1226 0.0543
(4.19) (0.05) (3.66) (0.47)
Corruption index 0.0187 0.0320 0.0095 0.0281
(7.03) (3.93) (2.09) (0.99)
GDP per capita 0.0062 0.0213
in 1960 (0.91) (0.96)
Secondary education 0.1749 0.1241
in 1960 (2.95) (1.21)
Population growth 0.8226 1.0160
(0.82) (1.05)
R
2
0.32 n.a.
b
0.44 n.a.
b
OLS = ordinary least-squares; 2SLS = two-stage least-squares; n.a. = not applicable.
a. There are 94 observations. The dependent variable is the average investment-GDP
ratio for 1960-85. The corruption index is the simple average of indices produced by
Political Risk Services, Inc. (compiled by the IRIS Center at the University of Maryland,
for 1982-95) and Business International (for 1980-83). One standard deviation of the
corruption index equals 2.38. A high value of the corruption index means that the country
has good institutions in that respect. White-corrected t-statistics are reported in parenthe-
ses. In the 2SLS regressions the index of ethnolinguistic fractionalization from Taylor and
Hudson (1972) was used as an instrumental variable.
b. R
2
is not an appropriate measure of goodness of fit with 2SLS.
Sources: Barro (1991); Business International; Political Risk Services, Inc.; IRIS Center,
University of Maryland.
annual grovlh in CDI per capila on lhe corruplion index (lable 2, col-
umn 1) also produced a significanl associalion. The magnilude of lhe
effecls is considerable: a one-slandard-devialion (2.38-poinl) improvemenl
in lhe corruplion index is associaled vilh over a 4-percenlage-poinl in-
crease in a counlrys inveslmenl rale and over a /-percenlage-poinl
increase in lhe per capila grovlh rale. This means lhal if a given coun-
lry vere lo improve ils corruplion grade from 6 oul of 10 lo 8 oul of
10, ils inveslmenl-CDI ralio vould rise by almosl 4 percenlage poinls
and ils annual grovlh of CDI per capila vould rise by almosl half a
percenlage poinl.
The eslimaled coefficienls become even larger vhen lvo-slage leasl-
squares lechniques, vilh lhe index of elhnolinguislic fraclionalizalion as
an inslrumenl, are used lo address possible endogeneily bias (lables 1
and 2, column 2). The relalionships remain significanl even in mulli-
variale regressions lhal lake inlo accounl lhe effecls of olher slandard
Table 2 Results of regressions estimating the effects of corruption
on growth of GDP per capita
a
Multivariate
including
Univariate, Univariate, Multivariate, Multivariate, investment,
Independent variable OLS 2SLS OLS 2SLS OLS
(1) (2) (3) (4) (5)
Constant 0.0035 0.0284 0.0012 0.0404 0.0012
(0.85) (2.12) (1.50) (0.81) (0.16)
Corruption index 0.0029 0.0081 0.0038 0.0175 0.0028
(4.74) (3.61) (2.95) (1.40) (2.01)
GDP per capita 0.0075 0.01821 0.0069
in 1960 (4.49) (1.79) (4.78)
Secondary education 0.0401 0.0034 0.0217
in 1960 (3.09) (0.09) (1.82)
Population growth 0.4124 0.5192 0.3255
(1.83) (1.29) (1.81)
Investment 0.1056
(3.09)
R
2
0.14 n.a.
b
0.31 n.a.
b
0.42
OLS = ordinary least-squares; 2SLS = two-stage least-squares; n.a. = not applicable.
a. There are 94 observations. The dependent variable is average annual growth of GDP per
capita for 1960-85. The corruption index is the simple average of indices produced by Political
Risk Services, Inc. (compiled by the IRIS Center at the University of Maryland, for 1982-95), and
Business International (for 1980-83). One standard deviation of the corruption index equals 2.38.
A high value of the corruption index means that the country has good institutions in that respect.
White-corrected t-statistics are reported in parentheses. In the 2SLS regressions the index of
ethnolinguistic fractionalization from Taylor and Hudson (1972) was used as an instrumental
variable.
b. R
2
is not an appropriate measure of goodness of fit with 2SLS.
Sources: Barro (1991); Business International; Political Risk Services, Inc.; IRIS Center, Univer-
sity of Maryland.
5. The specificalion chosen here is lhe base regression in Levine and Renell (1992) and
includes inilial CDI per capila, lhe inilial secondary educalion enrollmenl rale, and lhe
populalion grovlh rale.
delerminanls of inveslmenl and grovlh (lables 1 and 2, column 3).
5
The
magnilude of lhe coefficienls also rises vhen inslrumenlal variables are
used for lhe corruplion index in lhe mullivariale regressions (lables 1
and 2, column 4). Iinally, vhen lhe inveslmenl rale is added lo lhe lisl
of independenl variables in lhe grovlh regression, lhe coefficienl on lhe
corruplion index falls by lvo-lhirds (compare lable 2, column 5, vilh
lable 1, column 3), allhough il remains |usl significanl al lhe 5 percenl
level. This resull implies lhal much of lhe effecl of corruplion on eco-
nomic grovlh lakes place lhrough inveslmenl, allhough il leaves open
lhe possibilily lhal some of lhe effecl occurs direclly.
The general resull of lhese analyses-namely, lhal corruplion may
have large, adverse effecls on economic grovlh and lhal inveslmenl
may have imporlanl implicalions-has already received considerable al-
lenlion elsevhere.
6
The folloving seclion focuses on a channel olher
lhan inveslmenl lhrough vhich corruplion may affecl economic perfor-
mance, namely lhe possible link belveen corruplion and lhe composi-
lion of governmenl expendilure.
The LIIecIs oI 0orrupI|on on Ihe 0ompos|I|on
oI 6overnmenI Lxpend|Iure
6. A number of addilional robuslness lesls for similar regressions using lhe I dala sel
are reporled in Mauro (1993, 1995).
7. Levine and Renell (1992) shov lhal lhe overall level of governmenl expendilure does
nol seem lo bear any robusl relalionship vilh economic grovlh. Irevious vork on lhe
composilion of governmenl expendilure has been limiled. Devara|an, Svaroop, and Zou
(1993) find no clear relalionship belveen any componenl of governmenl expendilure
and economic grovlh. Laslerly and Rebelo (1993) do find some significanl relalionships:
public inveslmenl on lransporl and communicalions is posilively associaled vilh eco-
nomic grovlh, allhough nol vilh privale inveslmenl, public inveslmenl in agricullure is
negalively associaled vilh privale inveslmenl, general governmenl inveslmenl is posi-
lively correlaled vilh bolh grovlh and privale inveslmenl, and public enlerprise invesl-
menl is negalively correlaled vilh privale inveslmenl.
The polenlial effecls of corruplion on lhe composilion of governmenl
expendilure remain largely unexplored, al leasl in lhe conlexl of cross-
counlry vork. This seclion asks vhelher corrupl polilicians choose lo
spend more on lhose componenls of public expendilure on vhich il
may be easier or more lucralive lo levy bribes. The appendix derives a
generalizalion of lhe arro (1990) model lhal shovs lhal if corruplion
acled simply as lhough il vere a lax on income, lhen lhe amounl and
composilion of governmenl expendilure vould be independenl of cor-
ruplion. As a consequence, il seems reasonable lo inlerprel any empiri-
cal relalionships belveen corruplion indices and parlicular componenls
of governmenl spending as lenlalive evidence lhal corrupl bureaucrals
oblain more revenue for lhemselves nol simply by increasing govern-
menl expendilure and lheir share of il, bul also by shifling lhe composi-
lion of governmenl expendilure lo lhose areas in vhich bribes can be
more efficienlly collecled.
The queslion is inleresling because, even lhough lhe empirical lilera-
lure has so far yielded mixed resulls on lhe effecls of governmenl ex-
pendilure, and in parlicular of ils composilion, on economic grovlh,
7
mosl economisls seem lo lhink lhal lhe level and lype of spending un-
derlaken by governmenls do maller for economic performance. Ior ex-
ample, even lhough cross-counlry regression vork has nol conclusively
shovn a relalionship belveen governmenl spending on educalion and
economic grovlh, il has galhered fairly robusl evidence lhal school
enrollmenl rales (Levine and Renell 1992) and educalional allainmenl
(arro 1992) play a considerable role in delermining economic grovlh.
Ierhaps parl of lhe reason significanl and robusl effecls of lhe com-
posilion of governmenl expendilure on economic grovlh have proved
difficull lo find is lhal lhe qualily of lhe available dala may be relalively
lov, bolh because il is difficull lo ensure lhal all counlries apply lhe
same crileria in allocaling pro|ecls among lhe various calegories of gov-
ernmenl expendilure and because each public expendilure componenl
presumably conlains bolh produclive and unproduclive pro|ecls. The
relalive noisiness of lhe expendilure dala implies lhal lhis sludy musl
necessarily be exploralory and lhal one should nol expecl a priori lo
find significanl relalionships. Neverlheless, lhis seclion presenls nev,
lenlalive evidence lhal corrupl governmenls may display predalory be-
havior in choosing lhe composilion of governmenl expendilure. In
parlicular, governmenl spending on educalion seems lo be reduced by
corruplion.
Table 3 analyzes lhe relalionship belveen each componenl of public
expendilure (as a ralio lo CDI) reporled in lhe arro (1991) dala sel
and lhe corruplion index.
8
Covernmenl spending on educalion as a
ralio lo CDI is posilively and significanlly correlaled vilh lover levels
of corruplion (i.e., a higher ranking on lhe index). The magnilude of lhe
coefficienl is considerable: a one-slandard-devialion improvemenl in lhe
corruplion index is associaled vilh an increase in governmenl spending
on educalion by around half a percenl of CDI. Taken al face value, lhis
resull implies lhal if a given counlry vere lo improve ils grade on
corruplion from, say, 6 oul of 10 lo 8 oul of 10, on average ils govern-
menl vould increase ils spending on educalion by aboul half a percenl
of CDI. Iigure 1 shovs lhal lhis resull is nol |usl driven by a small
group of counlries.
lher componenls of governmenl expendilure (bul, inlereslingly,
nol lolal governmenl consumplion expendilure) are also significanlly
associaled vilh lhe corruplion index al lhe convenlional levels, mosl
nolably in lhe case of lransfer paymenls, and social insurance and
8. The various componenls of governmenl spending are analyzed as a share of CDI
because lhe generalizalion of lhe arro (1990) model lhal is derived in lhe appendix,
vhich provides a useful lheorelical benchmark, implies lhal if bribes could be levied |usl
as easily on all income (ralher lhan more easily on some governmenl expendilure com-
ponenls lhan olhers), lhen lhe various componenls of governmenl cs c rctic tc GDI
should be unrelaled lo corruplion.
Table 3 Results of regressions estimating the relationship between
corruption and the composition of government expenditure,
using the Barro data set
a
Dependent variable GDP per
(averages for 1970-85, Corruption capita
as percentages of GDP) Constant index (1980) R
2
N
Regressions omitting GDP
per capita as a variable
Government expenditure 0.028 0.0023 0.13 103
on education (7.48) (3.97)
Government consumption 0.213 0.0047 0.03 106
expenditure (11.85) (1.70)
Government consumption 0.146 0.0070 0.10 93
expenditure, excluding (10.69) (3.35)
education and defense
Government expenditure 0.032 0.0004 0.00 93
on defense (3.64) (0.28)
Government transfer 0.039 0.0208 0.45 73
payments (2.22) (7.22)
Social insurance and 0.044 0.0156 0.48 75
welfare payments (4.41) (7.94)
Regressions including GDP
per capita as a variable
Government expenditure 0.029 0.0020 0.0003 0.13 103
on education (6.85) (2.20) (0.43)
Government consumption 0.189 0.0052 0.0094 0.16 106
expenditure (10.20) (1.46) (4.88)
Government consumption 0.116 0.0049 0.011 0..25 93
expenditure, excluding (7.79) (1.41) (4.54)
education and defense
on defense (2.25) (0.25) (0.17)
Government transfer 0.013 0.0001 0.018 0.64 73
payments (0.78) (0.03) (5.60)
Social insurance and 0.015 0.0041 0.010 0.59 75
welfare payments (1.70) (1.64) (4.47)
a. The corruption index is the simple average of the indices produced by Political Risk
Services, Inc. (compiled by the IRIS Center, University of Maryland, for 1982-95) and
Business International (for 1980-83). One standard deviation of the corruption index
equals 2.38. A high value of the corruption index means that the country has good
institutions in that respect. White-corrected t-statistics are reported in parentheses. N is
the number of observations.
velfare paymenls. Hovever, il is imporlanl lo lake inlo accounl lhe
vell-knovn empirical observalion-knovn as Wagners lav
9
-lhal lhe
share of governmenl expendilure in CDI lends lo rise as a counlry
becomes richer. When lhe level of income per capila in 1980 is used as
an addilional explanalory variable, educalion lurns oul lo be lhe only
componenl of public spending vhose associalion vilh lhe corruplion
index remains significanl al lhe 95 percenl level.
10
The magnilude of lhe
coefficienl remains broadly lhe same as in lhe univariale regression.
Table 4 reporls resulls oblained using GlS dala, vhich are more finely
disaggregaled, allhough possibly al lhe cosl of lover cross-counlry
9. Laslerly and Rebelo (1993) reviev lhe lileralure on Wagners lav and shov lhal, in a
panel of counlries, several componenls of public spending rise (as a ralio lo CDI) as per
capila income rises.
10. This analysis is a firsl pass al lhe dala. Iulure research could inlroduce addilional
conlrol variables, such as lhe demographic slruclure of lhe populalion (a higher share of
lhe school-age populalion in lhe lolal populalion vould usually imply a higher expendi-
lure on educalion) and indicalors of relalions vilh neighboring counlries (an increased
possibilily of var is expecled lo raise defense spending).
Sources: Barro (1991), BI, and ICRG.
corruption and the composition of government expenditure,
using GFS data
a
(1985 observation, Corruption capita,
as ratio to GDP) Constant index 1980 R
2
N
Total government 0.233 0.0043 0.0112 0.122 88
expenditure (4.16) (0.36) (1.59) 2
Government current 0.141 0.0124 0.0094 0.238 85
expenditure (3.33) (1.34) (1.64) 8
Government capital 0.081 0.0064 0.0011 0.118 86
expenditure (4.54) (1.61) (0.43) 8
on education (3.95) (2.29) (1.93) 0
on schools (2.01) (1.60) (1.69) 7
on universities (2.71) (2.45) (2.79) 4
Other government 0.007 0.0001 0.0002 0.003 54
expenditure on education (1.93) (0.01) (0.29) 3
on health (0.13) (2.34) (1.27) 1
on hospitals (1.62) (0.64) (0.69) 3
on clinics (0.41) (1.02) (0.31) 3
Other government 0.001 0.0011 0.0009 0.042 44
expenditure on health (0.32) (0.83) (1.18) 2
on defense (2.42) (0.24) (0.41) 3
on transportation (4.13) (1.02) (0.39) 3
Services, Inc. (compiled by the IRIS Center, University of Maryland, for 1982-95) and
Business International (for 1980-83). One standard deviation of the corruption index
institutions in that respect. White-corrected t-statistics are reported in parentheses. N is
Sources: Government Finance Statistics (International Monetary Fund); Business Interna-
tional; Political Risk Services, Inc.; IRIS Center, University of Maryland.
comparabilily al lhe level of lhe more delailed ilems. Tolal governmenl
expendilure is again unrelaled lo corruplion, and lhe resulls oblained
vhen public expendilure is splil by funclion are in line vilh lhose ob-
lained using lhe arro dala sel. In parlicular, vhen CDI per capila is
conlrolled for, governmenl expendilure on educalion is negalively and
significanlly associaled vilh higher levels of corruplion (a lover ranking
on lhe index). Covernmenl expendilure on heallh is also found lo be
negalively and significanlly associaled vilh corruplion. Iinally, neilher
defense nor lransporlalion displays any significanl relalionship vilh cor-
ruplion. f course, lhis does nol mean lhal lhere is no corruplion asso-
cialed vilh spending on lhese ilems bul only lhal lhis simple analysis
does nol find any significanl evidence of il.
The link belveen corruplion and lhe subcomponenls of educalion
and of heallh expendilure is more blurred. The associalion is significanl
only for spending on primary and secondary educalion and on univer-
silies, and lhen only al lhe 90 percenl level.
Iinally, lable 4 shovs lhe resulls of lhe lesl of a hypolhesis oflen
heard in popular debale-namely, lhal corruplion is likely lo lead lo
high capilal expendilures by lhe governmenl, perhaps on useless vhile-
elephanl pro|ecls. The dala are consislenl vilh lhis hypolhesis bul do
nol provide significanl evidence in favor of il. In facl, an improvemenl
in lhe corruplion index does coincide vilh a decline in capilal expendi-
lure by lhe governmenl as a ralio lo CDI, bul lhis relalionship is barely
significanl al lhe 90 percenl level. Similarly, an improvemenl in lhe cor-
ruplion index is associaled vilh an increase in currenl expendilure by
lhe governmenl as a ralio lo CDI, bul nol significanlly so. Therefore,
lhese resulls are inleresling, bul only suggeslive al lhis slage.
The impacl of corruplion on lhe level and composilion of public in-
veslmenl vere analyzed using lhe dala from Laslerly and Rebelo (1993),
vhich unforlunalely reduces lhe sample size sharply. Inlereslingly, mosl
of lhe relalionships are nol slalislically significanl (lable 5). In parlicular,
allhough lhere is fairly robusl evidence lhal corruplion lovers lolal in-
veslmenl (and privale inveslmenl-see Mauro 1995), no clear relalion-
ship emerges belveen corruplion and public inveslmenl. A possible in-
lerprelalion is lhal predalory behavior by corrupl governmenls may help
suslain lhe level (allhough nol lhe qualily) of public inveslmenl as a
ralio lo CDI, even as privale inveslmenl declines. In addilion, none of
lhe componenls of public inveslmenl (including lhe educalion compo-
nenl) is significanlly associaled vilh lhe corruplion indices. In parl, lhese
findings may be due lo lhe facl lhal lhe sample is relalively small and
consisls only of developing counlries, yielding relalively lillle varialion
in lhe independenl variables. Hovever, il is also possible lo speculale
lhal bribes are difficull lo levy on leachers salaries bul easier lo levy on
lhe conslruclion of school buildings.
Iinally, lable 6 reporls resulls from a number of simple lesls of lhe
corruption and the composition of public investment
a
(1985 observation, Corruption capita,
as ratio to GDP) Constant index 1980 R
2
N
Public investment 0.110 0.0041 0.051 84
(8.45) (1.95)
Public investment 0.098 0.0009 0.0060 0.121 84
(6.67) (0.29) (2.75)
General government 0.051 0.0014 0.021 51
(4.76) (0.92)
General government 0.038 0.0030 0.0040 0.126 51
(2.34) (0.85) (1.98)
Public enterprises 0.060 0.0022 0.028 42
(4.93) (1.21)
Public enterprises 0.042 0.0052 0.0079 0.224 42
(3.83) (2.15) (4.21)
Agriculture 0.021 0.0010 0.013 44
(2.15) (0.55)
Agriculture 0.023 0.0007 0.0021 0.033 44
(2.42) (0.37) (1.34)
Education 0.006 0.0001 0.001 42
(2.58) (0.11)
Education 0.0058 0.0003 0.0008 0.035 42
(2.68) (0.49) (1.69)
Health 0.004 0.0001 0.001 37
(2.59) (0.14)
Health 0.0046 0.0001 0.0007 0.038 37
(2.92) (0.19) (1.88)
Housing 0.004 0.0003 0.006 31
(1.41) (0.57)
Housing 0.0049 0.0008 0.0016 0.056 31
(1.60) (1.16) (1.82)
Industry 0.011 0.0001 0.001 32
(1.79) (0.10)
Industry 0.011 0.0001 0.0003 0.002 32
(1.88) (0.05) (0.28)
Transportation 0.018 0.0004 0.004 36
(3.94) (0.45)
Transportation 0.019 0.0005 0.0005 0.007 36
(3.93) (0.55) (0.43)
Services, Inc. (compiled by the IRIS Center, University of Maryland, for 198295) and
Business International (for 198083). One standard deviation of the corruption index
institutions in that respect. Whitecorrected tstatistics are reported in parentheses. N is
Table 6 Results of regressions estimating the relationship between corruption
and government expenditure on education
a
Government
GDP per consumption
Dependent variable Corruption capita, expenditure as
(average 1970-85) Constant index 1980 ratio to GDP R
2
N
Ratio of government expenditure 0.010 0.0027 0.0863 0.278 103
on education to GDP (2.25) (5.48) (4.74)
Ratio of government expenditure 0.009 0.0014 0.0013 0.1042 0.318 103
on education to GDP (2.15) (1.62) (1.75) (4.74)
Ratio of government expenditure 0.103 0.0256 0.262 103
on education to government (4.11) (5.40)
consumption expenditure
Ratio of government expenditure 0.149 0.0056 0.0187 0.424 103
on education to government (6.49) (1.09) (5.00)
consumption expenditure
Ratio of government expenditure 0.036 0.0011 n.a.
b
100
on education to GDP; (4.08) (0.74)
instrument: fractionalization
1
0
0
I
n
s
t
i
t
u
t
e

f
o
r

I
n
t
e
r
n
a
t
i
o
n
a
l

E
c
o
n
o
m
i
c
s

|

h
t
t
p
:
/
/
w
w
w
.
i
i
e
.
c
o
m
b
100
on education to GDP; (5.08) (1.36)
instruments: fractionalization,
colonial history, and postwar
independence
b
100
consumption expenditure;
instrument: fractionalization
b
100
consumption expenditure;
instruments: fractionalization,
colonial history, and postwar
independence
n.a. = not applicable
a. The corruption index is the simple average of the indices produced by Political Risk Services, Inc. (compiled by the
IRIS Center, University of Maryland, for 1982-95) and Business International (for 1980-83). One standard deviation of
the corruption index equals 2.38. A high value of the corruption index means that the country has good institutions in
that respect. White-corrected t-statistics are reported in parentheses. N is the number of observations. Fractionalization
is the index of ethnolinguistic fractionalization in 1960, from Taylor and Hudson (1972). Colonial history is a dummy
for whether the country was ever a colony (since 1776). Postwar independence is a dummy for whether the country
was still a colony in 1945.
b. R
2
is not an appropriate measure of goodness of fit with instrumental variables (two-stage least-squares).
Sources: Barro (1991); Business International; Political Risk Services, Inc.; IRIS Center, University of Maryland.
1
0
1
I
n
s
t
i
t
u
t
e

f
o
r

I
n
t
e
r
n
a
t
i
o
n
a
l

E
c
o
n
o
m
i
c
s

|

h
t
t
p
:
/
/
w
w
w
.
i
i
e
.
c
o
m
robuslness of lhe relalionship belveen corruplion and governmenl ex-
pendilure on educalion. This robuslness is lesled, firsl, by relaxing some
of lhe previous eslimales assumplions on funclional form and, second,
by conlrolling for possible endogeneily problems by using inslrumenlal
variables. When lhe ralio of governmenl expendilure on educalion is
regressed on lhe corruplion index and lolal governmenl expendilure as
a ralio lo CDI, lhe relalionship remains significanl, bul only barely so
vhen CDI per capila is included in lhe specificalion. Covernmenl ex-
pendilure on educalion as a share of lolal governmenl consumplion
expendilure is significanlly correlaled vilh lhe corruplion index, bul only
vhen CDI per capila is nct included in lhe regression. Thus, lhe rela-
lionship belveen corruplion and governmenl expendilure on educalion
seems lo be somevhal sensilive lo changes in lhe specificalion, bul nol
overly so.
To lhe exlenl lhal lhe direclion of causalily lo be caplured is lhal
from corruplion lo governmenl spending on educalion, il is inleresling
lo eslimale lhis relalionship using inslrumenlal variables (lhe index of
elhnolinguislic fraclionalizalion and lhe colonial dummies). The coeffi-
cienl on corruplion falls by aboul half in lhe regression of governmenl
expendilure on educalion as a ralio lo CDI vhen inslrumenlal vari-
ables are used (compare lable 6, rovs 5 and 6, vilh lable 3, rov 1).
Hovever, lhe use of inslrumenlal variables raises lhe coefficienl on cor-
ruplion in lhe regression of governmenl expendilure as a share of lolal
governmenl consumplion expendilure (in lable 6, compare rovs 7 and
8, vilh lable 3, rov 3). Thus, lhere is some lenlalive supporl for lhe
hypolhesis lhal corruplion ccuscs a decline in governmenl expendilure
on educalion, bul lhe resulls are somevhal mixed.
verall, lhe evidence is suggeslive, bul by no means conclusive, lhal
corruplion is negalively associaled vilh governmenl expendilure on educa-
lion and possibly on heallh. Despile some indicalions lhal lhe direclion
of lhe causal link may be al leasl in parl from corruplion lo lhe com-
posilion of spending, lhe issue of lhe direclion of causalily remains
unresolved. Al lhe same lime, lhe exlenl lo vhich polenlial policy con-
clusions depend on lhe direclion of causalily should nol be overslaled-
an issue lhal lhe nexl seclion explores.
Ior lhe sake of clarily, lhe above lisl of variables lhal mighl be relaled
lo corruplion has been presenled as lhough lhese variables could un-
ambiguously be calegorized as eilher causes or consequences of cor-
ruplion. ul in facl lhe direclion of causalily is blurred in some cases.
Ior example, il is nol clear vhelher lhe exislence of regulalions leads
The Direction of CausaIity~Is It ReIevant
for PoIicy?
bureaucrals lo ask for bribes lo help enlrepreneurs circumvenl lhem, or
inslead vhelher corrupl bureaucrals are more likely lo mulliply regula-
lions as a vay of crealing opporlunilies for bribes. The same is lrue for
lhe empirical relalionship on vhich lhis chapler focuses: |usl as lhe
exislence of corruplion may cause a less-lhan-oplimal composilion of
governmenl expendilure, so il may be lhal high governmenl spending
on ilems vhere moniloring is difficull creales opporlunilies for corrup-
lion. The empirical seclion of lhis chapler has made some allempls lo
idenlify lhe correcl direclion of lhe causal links. ul lhe issue of causal-
ily has nol been-and may never be-fully resolved, since causalily may
vell operale in bolh direclions.
In general, lhe direclion of causalily has imporlanl implicalions for
policy prescriplions, bul in some cases policy conclusions are nol en-
lirely dependenl on il. In lhe specific case of lhe composilion of govern-
menl spending, ils observed correlalion vilh corruplion may conslilule
grounds for considering vhelher governmenls should be encouraged lo
allocale a larger proporlion of lheir spending lo lhose ilems lhal are less
susceplible lo corruplion, sub|ecl lo lhe folloving qualificalions.
If a less-lhan-oplimal composilion of governmenl spending causes cor-
ruplion in lhe sense of crealing opporlunilies for il, lhen encouraging
governmenls lo improve lhe composilion of lheir spending mighl be an
effeclive vay of reducing corruplion. If, on lhe olher hand, il is corrup-
lion lhal causes a less-lhan-oplimal composilion of governmenl expen-
dilure,
11
lhen corrupl governmenls vill allempl lo circumvenl any efforl
lo encourage lhem lo spend proporlionalely more on aclivilies lhal are
less susceplible lo corruplion. In facl, corrupl governmenls could lhvarl
such pressure by subsliluling publicly unproduclive bul privalely lucra-
live pro|ecls for publicly produclive bul privalely unlucralive ones uitnin
a given expendilure calegory and slill be able lo shov, for example, lhal
lheir share of spending on educalion has risen. In such a case, vould
encouraging governmenls lo improve lhe composilion of lheir spending
be an effeclive vay of curbing corruplion` The ansver hinges on vhelher,
as a praclical maller, il is possible lo specify lhe composilion of govern-
menl expendilure in a vay lhal makes il difficull for corrupl officials lo
find scope for raising bribes vhile slill appearing lo adopl a more desir-
able composilion of governmenl spending.
Therefore, even if a priori consideralions and lhe lenlalive evidence
presenled above suggesl lhal any correlalion belveen corruplion and
lhe composilion of governmenl spending reflecls al leasl in parl causal-
ily running from lhe former lo lhe laller, encouraging governmenls lo
improve lhe composilion of lheir spending may slill be an effeclive vay
11. The eslimales in lable 6 provide lenlalive evidence lhal lhe observed correlalion
belveen corruplion and governmenl expendilure composilion may be due al leasl in
parl lo lhis mechanism.
of curbing corruplion. Hovever, il is so only lo lhe exlenl lhal lhe com-
posilion of spending may be specified so as lo make subslilulion uitnin
ils calegories difficull.
This appendix develops a simple generalizalion of lhe arro (1990) model,
vhich may conslilule a useful benchmark lo analyze lhe relalionship
belveen corruplion and lhe composilion of governmenl expendilure. Il
shovs lhal if corruplion acled simply as a proporlional lax on income,
lhe ralio of each componenl of governmenl expendilure lo CDI vould
be lhe same, no maller hov corrupl or unslable lhe governmenl.
Iolloving arro (1990), laxes are assumed lo be levied as a propor-
lion of income. The produclion funclion is assumed lo be of lhe form:
~ A |
(1 - a)

i ~ 1
g
i
ai
,
i ~ 1
a
i
~ a, 0 < a < 1 (1)
P PP PP S SS SS
|
ConcIuding Remarks
This chapler has analyzed a number of lhe causes and consequences of
corruplion. Il has revieved and synlhesized recenl sludies lhal have
eslimaled some of lhese links empirically, bul olhers remain on lhe
agenda for fulure research. In addilion, lhe chapler has presenled furlher
evidence (vhich musl, hovever, be inlerpreled vilh caulion, given lhe
dala limilalions menlioned) lhal corruplion may have considerable ad-
verse effecls on economic grovlh, largely by reducing privale invesl-
menl, bul perhaps also lhrough a variely of olher channels, vhich may
include a vorsening in lhe composilion of public expendilure. Specifi-
cally, lhis chapler has presenled nev, lenlalive evidence of a negalive and
significanl relalionship belveen corruplion and governmenl expendilure
on educalion. This evidence is reason for concern, since previous lilera-
lure has shovn lhal educalional allainmenl is an imporlanl delerminanl
of economic grovlh. A possible inlerprelalion of lhe observed correlalion
belveen corruplion and lhe composilion of governmenl expendilure is
lhal corrupl governmenls find il easier lo collecl bribes on some expen-
dilure ilems lhan on olhers. Allhough one policy implicalion mighl be
lhal governmenls should be encouraged lo shifl lhe composilion of lheir
expendilure, an imporlanl issue is vhelher, as a praclical maller, lhe
desired composilion can be specified in a vay lhal corrupl officials could
nol circumvenl by subsliluling publicly unproduclive bul privalely lucra-
live pro|ecls uitnin lhe various expendilure calegories.
Appendix: A GeneraIization of the Barro ModeI
as a Benchmark
|
S SS SS
|
1 - s
vhere is income per vorker, A is a lechnological parameler, | is pri-
vale capilal per vorker, and g
i
is lhe flov of public services from
governmenl expendilure of lype i, per vorker. This is lhe simple exlen-
sion lo | lypes of governmenl expendilure of lhe produclion funclion
in Devara|an, Svaroop, and Zou (1993).
Defining f
i
so lhal:
g
i
~ f
i
g,
i ~ 1
f
i
~ 1 (2)
vhere g is lhe lolal flov of public services from produclive governmenl
expendilure per vorker, lhe produclion funclion in equalion (1) reduces
lo lhe arro (1990) produclion funclion if | ~ 1.
arro (1990) examines lvo exlreme cases. In lhe firsl, a benevolenl
governmenl maximizes lhe lifelime ulilily of lhe represenlalive consumer,
sub|ecl lo lhe conslrainl lhal t ~ g, solving for lhe oplimal t yields
t
~ (g)
~a. In lhe second, a self-inleresled governmenl (of infinile

duralion in office) oblains consumplion equal lo C
g
~|t- (g)], lhal is,
corrupl bureaucrals gel lo consume lhe budgel surplus (t represenls
lhe sum of a proporlional lax rale and a proporlional bribe rale). The
self-inleresled governmenl maximizes lhe presenl value of lhe fulure
flov of ulilily derived from C
g
, sub|ecl lo t g.
To analyze lhe role of inslilulions in delermining lhe composilion of
public expendilure, il is inleresling lo analyze lhe problem of a govern-
menl lhal maximizes a veighled average of lhe lifelime ulilily of lhe
represenlalive consumer and of lhe lifelime ulilily derived from con-
sumplion by ils self-inleresled members. The maximizalion program may
be expressed as, choose t and {g), sub|ecl lo t g, so as lo maximize,
(1 - y) U + y U
g
, vilh 0 y 1, and vhere U is lhe lifelime ulilily of
lhe represenlalive consumer and Ug is lhe lifelime ulilily of lhe self-
inleresled governmenl official.
Iolloving arro (1990), lhe lifelime ulilily of lhe cilizen can be as-
sumed lo be:
U ~ c
-rt

c
1-s

- 1
dt (3)
(
(
1 - s
)
)
vhere r is lhe rale of lime preference and s is lhe inverse of lhe inler-
lemporal elaslicily of subslilulion. Similarly, lhe lifelime ulilily of lhe
self-inleresled governmenl official can be assumed lo be:
U
g
~

c
-qt

c
g
1-s

- 1
dt (4)
vhere q is lhe sum of lhe governmenl officials rale of lime preference
and of his probabilily of dealh (a melaphor for governmenl collapse, for
analylical simplicily).
0

arro (1990) analyzes special cases (i and ii) of lhe above maximiza-
lion program, vhere y ~ 0 and y ~ 1, respeclively. The veighl given
lo lhe lifelime ulilily of lhe self-inleresled governmenl officials, y, may
be laken lo represenl lhe degree lo vhich lhe counlry is corrupl.
Il can be shovn lhal lhe more corrupl (higher y) and lhe more un-
slable (higher q) lhe governmenl, lhe higher is t, and lherefore lhe lover
are privale inveslmenl and economic grovlh. This resull is consislenl
vilh lhe observalion in lhis chapler lhal corruplion reduces privale in-
veslmenl and grovlh.
n lhe olher hand, in lhis model il can also be shovn lhal lhe opli-
mal share of governmenl infraslruclure services is independenl of cor-
ruplion and polilical slabilily, lhal is, {g)

~ a, regardless of lhe veighls
assigned lo lhe lvo classes of people and regardless of lhe discounl
rale. A proof of lhis proposilion can be oblained by simply laking de-
rivalives of (1 - y) U + y U
g
vilh respecl lo t and g. A fev pages of
algebra (nol reproduced here) yield lhe resull.
The folloving condilion relaling lo lhe composilion of produclive
governmenl expendilure maximizes lhe lifelime ulilily of bolh lhe rep-
resenlalive consumer and lhe self-inleresled bureaucral:
f
j

~

a
i
,
"j, | (5)
As a consequence, any governmenl vould choose lhe composilion of
expendilure implied by equalion (5), regardless of lhe degree of corrup-
lion and polilical inslabilily. Therefore, under lhe assumplions of lhe
arro (1990) model, and mosl nolably lhe assumplion lhal corruplion
acls as a proporlional lax on income, lhe ralio of each componenl of
governmenl expendilure lo CDI vould be lhe same, no maller hov
corrupl or unslable lhe governmenl.
Ades, Alberlo, and Rafael Di Tella. 1994. Ccmpctiticn cnd Ccrrupticn. Inslilule of Lconom-
ics and Slalislics Discussion Iapers 169. xford, UK: Universily of xford.
Ades, Alberlo, and Rafael Di Tella. 1995. Nalional Champions and Corruplion: Some
Unpleasanl Compeliliveness Arilhmelic. Universily of xford. Iholocopy.
arro, Roberl. 1990. Covernmenl Spending in a Simple Model of Lndogenous Crovlh.
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arro, Roberl. 1991. Lconomic Crovlh in a Cross-Seclion of Counlries. Qucrtcr| jcurnc|
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arro, Roberl. 1992. Human Capilal and Lconomic Crovlh. In Ic|icics (cr Lcng-Run
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~a. In lhe second, a self-inleresled governmenl (of infinile

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