The assertion that corruption is an observed phenomenon (or so-called stylized fact) in most--if not all--countries seems undisputed. The incidence of corruption is arguably greater in institutional settings exhibiting large and pervasive bureaucracies, deficient judicial systems, bureaucratic incompetence, ill-defined property rights, and microeconomic controls, as all give rise to complex and time-consuming procedures, that is, “red tape.” Such environments constrain foreign investors, domestic producers, and consumers, who, as a result, often succumb to “illegal taxation,” that is, bribery of bureaucrats in key positions, whose capacity to absorb bribes is facilitated by the above-described settings.
Reforming economies have typically focused their reform plans on fiscal deficit reductions, privatization schemes, and restoration of the price system’s role in allocating resources and conveying information. Although little attention has been given thus far to the impact of illegal activities on the success of reform/stabilization packages and optimal policy design, there is a need to establish a framework in which to assess an economy’s response to alternative stabilization/reform packages as a function of the scope of corruption activities. This paper aims to develop one such framework, in which only the most fundamental questions, such as the effects of government anticorruption policies on output and welfare, are examined.
This paper studies the relationship between corruption and capital accumulation using a dynamic model in which the government is assumed to observe bribe activity imperfectly. The model differentiates between developing and developed economies according to the income share accruing to capital, which is higher for developing countries.
The model provides several interesting results. For example, it shows that reductions in public good output, as a fraction of the economy’s total expenditure, lead to larger welfare decreases when in the presence of corruption. Also, the framework can accommodate political-economy analysis and is able to explain why, even when it is possible to eliminate corruption activity altogether, governments may choose not to do so. Moreover, the model also predicts that the effect of anticorruption penalties on the economy’s capital stock can be greater in developing countries; in particular, it finds that the elasticity of the steady state average per capita stock of capital with respect to increases in anticorruption penalties is increasing in the income share accruing to capital.