Economics Letters 66 (2000) 199202

www.elsevier.com / locate / econbase

Corruption and inflation

Fahim A. Al-Marhubi*
Sultan Qaboos University, College of Commerce and Economics, P.O. Box 20, Post Code 123, Al-Khoudh, Oman
Received 18 September 1998; accepted 20 April 1999

Abstract
This paper analyzes the relationship between corruption and inflation. Using alternative indicators of
corruption, I find a significant positive association between corruption and inflation, even after controlling for a
variety of other determinants of the latter. 2000 Elsevier Science S.A. All rights reserved.
Keywords: Inflation; Corruption
JEL classification: E31; E62

1. Introduction
During the last decade there has been considerable research on the macroeconomic consequences of
corruption. Most of the academic literature on this subject has studied the effects of corruption on
static efficiency, investment, and economic growth. Missing from recent discussions of corruption is
any systematic analysis of the effects of corruption on inflation. This is surprising given the recent
explosion of interest in the political-economy determinants of inflation.
There are a number of reasons why inflation and corruption may be linked. First, according to the
theory of optimal taxation, governments may have a motive for creating inflation, so as to generate
seigniorage. Tax evasion and tax collection costs may make it optimal for the government to rely on
the inflation tax as a source of government revenue. Clearly, tax evasion and tax collection costs are
likely to be greater in countries that are more corrupt. Second, businesses are likely to respond to
corruption by going underground, thereby increasing reliance on the inflation tax. Third, corruption
may also lead to capital flight, which shrinks taxable assets and income of those most able to meet
government revenue requirements. Finally, by reducing revenues and increasing public spending,
corruption may also contribute to larger fiscal deficits, which may have inflationary consequences for
countries with less developed financial markets.
*Tel.: 1 968-51-58-18; fax: 1 968-51-40-43.
E-mail address: faaam@gto.net.om (F.A. Al-Marhubi)
0165-1765 / 00 / $ see front matter 2000 Elsevier Science S.A. All rights reserved.
PII: S0165-1765( 99 )00230-X

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F. A. Al-Marhubi / Economics Letters 66 (2000) 199 202

The impact of corruption on inflation is ultimately an empirical question. Drawing on the political
economy approach to inflation, this paper provides evidence on the extent to which corruption
explains cross-country inflation differentials.1

2. Methodology and data description

The significance of the inflation-corruption link is evaluated using the positive political-economy
approach to inflation. This conceptual framework analyzes the underlying incentives and constraints
faced by policy-makers in their strategic decisions regarding monetary policy. This literature has
provided some important insights into the effectiveness of different pre-commitment devices in
containing inflationary forces and the institutional and political factors that contribute to the
development of inflationary pressures. Variables that have received the most attention in this literature
are used as control variables. These include indicators of central bank independence and political
instability, the level of economic development, and openness of the economy.2 Dummy variables for
Asia and Latin America are included to capture other elements determining inflation that are not
captured in the analysis.
The analysis is based on cross-country data consisting of 41 countries for which data is available on
four alternative indices of corruption. Ideally, measures of corruption would consist of objective
evaluations that are comparable across countries and over time. Ideal measures such as these do not as
yet exist. In their absence, indicators have been developed that are based on foreign businessmen and
international correspondents perceptions of corruption.3 The first two indicators are from Transparency International and are based on perceptions drawn mostly from people in multinational firms
and institutions for the years 198892 and 198085, respectively. The third index is the Business
International (BI) measure of corruption based on perceptions drawn from BI overseas correspondents
in the years 198083. This indicator is taken from Mauro (1995). The last indicator is Mauros (1995)
bureaucratic efficiency index. All indices range from 10 (no corruption) to 0 (maximum corruption).
All remaining variables are averaged over the period 198095, except where otherwise noted.
Inflation is measured as the logarithm of the average annual percentage change in the GDP deflator.
The level of economic development is measured by per capita real GDP. Openness is measured by the
ratio of imports and exports to GDP. All data were obtained from the World Development Indicators
1997 on CD-ROM. The index of central bank dependence is the turnover of central bank governors
compiled by Cukierman et al. (1992).

3. Empirical results
Table 1 contains the results obtained from OLS estimation. Most of the coefficients have the
expected signs, even though not all are statistically significant. All indicators of corruption enter the
1

To my knowledge, this is the first systematic cross-country analysis that relates indicators of corruption to inflation.
For models that argue for the inclusion of these variables and empirical evidence, see Lane (1997), Romer (1993),
Cukierman (1992), and Cukierman et al. (1992).
3
Indicators based on perceptions, however, have significant drawbacks. See, for example, Bardhan (1997) and Tanzi
(1998).
2

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201

Table 1
Dependent variable: logarithm of average annual inflation (198095)a

Constant
Openness
Per capita real GDP
Turnover of central
bank governors
Asia
Latin America
Corruption 1

(1)

(2)

(3)

(4)

3.32**
(2.97)
2 2.78E-03*
(2.01)
2 0.06
(0.37)
3.44**
(4.86)
2 1.22**
(4.22)
0.19
(0.45)
2 0.17**
(2.87)

3.08**
(3.06)
2 2.75E-03*
(2.23)
2 3.44E-03
(0.02)
3.41**
(5.30)
2 1.25**
(4.39)
0.19
(0.44)

3.38**
(3.29)
2 2.96E-03*
(2.47)
7.75E-03
(0.05)
3.86**
(5.75)
2 1.38**
(4.21)
0.05
(0.10)

3.78**
(4.07)
2 2.16E-03
(1.95)
2 4.45E-03
(0.03)
3.34**
(5.64)
2 1.23**
(5.01)
0.28
(0.83)

2 0.21**
(2.86)

Corruption 2

2 0.22**
(2.82)

Corruption 3
Corruption 4
Adjusted R 2
Observations

0.68
41

0.70
41

0.70
41

2 0.26**
(3.67)
0.72
41

a
Figures in parentheses are heteroscedastic-consistent t statistics.
* and ** denote significance at 5 and 1%, respectively.

inflation equations with negative and significant coefficient estimates, suggesting that, other things
given, countries with more corruption experienced higher inflation.4 The prediction that more open
economies and countries with more independent central banks will have lower inflation is also borne
out by the regression results. Finally, the significantly negative estimates on the Asian dummy suggest
that there are other variables determining inflation that are not fully captured in the analysis.

4. Conclusions
Corruption has been blamed for many poor macroeconomic outcomes such as low investment and
slow growth. This paper has extended the list of negative consequences of corruption and argued that
it is also partly responsible for high inflation. The empirical evidence presented suggests that higher
corruption is associated with higher inflation. The relationship is robust to the inclusion of other
determinants of inflation, including the degree of central bank independence, political instability, and
other structural characteristics. From a policy perspective, the main implication of this finding is that
reforming economic and political institutions to strengthen the rule of law and reduce corruption
should be part of the agenda for any meaningful policy reform.
4

The inflationcorruption link is robust to the inclusion of political instability, taken from Barro (1991).

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F. A. Al-Marhubi / Economics Letters 66 (2000) 199 202

References
Bardhan, P., 1997. Corruption and development: a review of issues. Journal of Economic Literature XXXV, 13201346.
Barro, R., 1991. Economic growth in a cross section of countries. Quarterly Journal of Economics 106, 407443.
Cukierman, A., 1992. In: Central Bank Strategy, Credibility and Independence: Theory and Evidence, Cambridge University
Press, Cambridge.
Cukierman, A., Edwards, S., Tabellini, G., 1992. Seigniorage and political instability. American Economic Review 82,
537555.
Lane, P., 1997. Inflation in open economies. Journal of International Economies 42, 327347.
Mauro, P., 1995. Corruption and growth. Quarterly Journal of Economics, 110, 681, 712.
Romer, D., 1993. Openness and inflation, Quarterly Journal of Economics CVIII, 869903.
Tanzi, V., 1998. Corruption around the world: causes, consequences, scope, and cures. IMF Working Paper WP/ 98 / 63, 139.