There is increasing recognition that corruption has substantial, adverse effects on economic growth. But if the costs of corruption are so high, why don’t countries strive to improve their institutions and root out corruption? Why do many countries appear to be stuck in vicious circles of widespread corruption and low economic growth, often accompanied by ever-changing governments through revolutions and coups? A possible explanation is that when corruption is widespread, individuals do not have incentives to fight it even if everybody would be better off without it. Two models involving strategic complementarities and multiple equilibria attempt to illustrate this formally. [JEL 040, H5, D73]
A consensus seems to have emerged that corruption and other aspects of poor governance and weak institutions have substantial, adverse effects on economic growth. Nevertheless, many countries seem to be unable to improve their institutions and curb corruption. Economists and policymakers have long recognized that institutions matter in determining economic performance.1 The modern economic literature on rent seeking has analyzed the relationship between trade distortions, rent seeking behavior, and economic inefficiencies (Krueger, 1974). North (1990) has argued that weak property rights may worsen a country’s economic performance. Murphy, Shleifer, and Vishny (1991) have suggested that countries where talented people are allocated to rent-seeking activities will tend to grow more slowly. The recent availability of indices of corruption has stimulated a flurry of empirical studies (for example, Kaufmann, Kraay, and Zoido-Lobatón, 1999; Knack and Keefer, 1995; and Mauro, 1995) that have generally concluded that the economic costs of corruption and weak governance are substantial. In the policy arena, several initiatives have been undertaken in an effort to reduce corruption: one such example is the 1997 OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions. International organizations also have become much more openly involved in promoting good governance.2
Despite a fairly clear understanding of the causes and consequences of corruption, and renewed attention on the part of policymakers, countries’ relative degree of corruption has proved to be remarkably persistent. Some countries appear to be stuck in a bad equilibrium characterized by pervasive corruption with no sign of improvement. Interestingly, other countries experience corruption to an extent that seems to be much lower, and persistently so.
One reason why rooting out corruption is so difficult may be that when corruption is widespread, it just does not make sense for individuals to attempt to fight it, even if everybody would be better off if corruption were eliminated. Consider for example the case of a civil servant in an administration where everybody, including his superiors, is very corrupt. It would be difficult for this civil servant to decline offers of bribes in exchange for favors because his superiors may expect a portion of the bribe for themselves.3 By contrast, in bureaucracies that are generally honest, a real threat of punishment deters individual civil servants from behaving dishonestly. This is an example of a strategic complementarity, whereby if one agent does something it becomes more profitable for another agent to do the same thing. Models involving strategic complementarities lead to multiple equilibria—in this case a good equilibrium with low corruption, and a bad equilibrium with pervasive corruption.
Several authors have pointed to strategic complementarities as a major factor in determining a country’s institutional efficiency and economic performance. Putnam (1993) has argued that a tragedy of the commons may explain the institutional and economic failure of some Italian regions. Strategic complementarities have received attention previously in the context of formal models of corruption but have not been explicitly related to economic growth. Andvig and Moene (1990) have emphasized that the expected profitability of corruption from an individual point of view is a positive function of the degree to which a society as a whole is corrupt.4 They have shown that this may lead to multiple self-fulfilling equilibrium levels of corruption. Murphy, Shleifer, and Vishny (1993) have shown that increasing returns in rent seeking activities may generate multiple equilibria in rent seeking and income levels.5
Strategic complementarities are consistent with the observation that the degree of institutional efficiency is extremely persistent over time. Putnam (1993) shows that the ranking of Italian regions by “civicness” is almost the same today as it was a century ago.6 In the cross-country context, indices of corruption or institutional strength, which are available for the past two or three decades, also tend to be very stable over time.
Multiple equilibria and strategic complementarities are one, perhaps intuitively appealing, way of understanding the persistence of corruption, but other studies have used different approaches. Tirole (1996) analyzes the interaction between the reputation of a group and its individual members. As individuals’ actions cannot be perfectly observed, their reputations depend partly on the past behavior of the group to which they belong. Individuals who belong to a group with a reputation for being corrupt will therefore have a strong incentive to be corrupt too. This generates history-dependence as corruption is perpetuated within a group: indeed temporary increases to corruption may not subside even after the generations that committed the original sin have by and large disappeared. In a related vein, Sah (1988 and 1991) explains differences in crime participation rates across otherwise similar societal groups on the basis of learning models in which it is easier to observe members of one’s own group, and in which individuals’ present behavior is affected by the behavior of past generations. These papers emphasize an intergenerational aspect that is not addressed in this paper and do not focus on multiple equilibria. Nevertheless, they rely on the interaction between a group’s behavior and individual behavior. More generally, persistent differences in economic performance across countries have been analyzed by Azariadis (2001), Ciccone and Matsuyama (1996), and Matsuyama (1996) using models in which adverse initial conditions may lead to poverty traps.
This paper presents two models based upon strategic complementarities, in an attempt to formalize the general observation that some countries seem to be stuck in a bad equilibrium characterized by both widespread corruption and slow economic growth. The two models are complementary, as they view corruption from slightly different angles.
The first model (Section I) displays multiple equilibria in corruption and growth. Its contribution is to obtain this result in the context of a modern growth model. Individuals allocate their time between productive work activity and theft from government expenditure. In turn, the services resulting from government expenditure enter the production function as in Barro (1990). The model draws on a strategic complementarity similar to that analyzed by Murphy, Shleifer, and Vishny (1993): if many people steal, then the probability of any one of them being caught will be low. Thus there will be a “good” equilibrium characterized by absence of corruption and high rates of investment and growth; and a “bad” equilibrium characterized by pervasive corruption and low investment and growth. Slow growth and low investment in the bad equilibrium result from (i) the waste of labor hours spent on unproductive transfer of resources, in the spirit of the initial literature on rent seeking, and (ii) a low marginal product of capital, because a lower proportion of government expenditure reaches the production processes of which it is an input.
The second model (Section II) displays multiple equilibria in corruption, political instability, and economic growth. One of its objectives is to suggest that corruption and political instability may be two sides of the same coin.7 The contribution of the model resides in its linking corruption and politicians’ horizons and drawing the implications of this link for economic growth. The model considers a game among politicians, each of whom has to decide what kind of private bribe collection system he wishes to set up. In doing so, politicians have to take into account the fact that if they hurt the economy, then citizens will not reelect them, so that they will no longer be able to collect bribes in the future. The strategic complementarity in the model can be described in intuitive terms as follows. Individuals A and B are members of the same government. Suppose that A is very corrupt and has established a private bribe-collection system for his own gain. The need to pay substantial bribes reduces entrepreneurs’ incentives to invest and imposes a significant burden on economic growth. Citizens realize that economic growth is being harmed by the corrupt government, though they may not know exactly who is soliciting bribes. Therefore, they decide not to reelect the government. This shortens B’s horizon, making him more inclined to extract a large share of current output and to disregard any ensuing adverse effects on future output. In other words, B will seek to obtain a large slice of the cake today and disregard policies aimed at increasing the size of the cake tomorrow, since he knows that the government he participates in will soon be ousted. If, on the other hand, A does not collect bribes, then—following similar reasoning—B will also refrain from doing so.
Not surprisingly, these models do not provide magic bullets or precise policy conclusions, but they do yield some interesting results. One broad conclusion, as is often the case with models involving strategic complementarities and multiple equilibria, is that gradual reforms are less likely to work than more ambitious, comprehensive reforms. Another conclusion is that countries left to their own devices may be unable to get out of the vicious circles they seem to be stuck in. This may strengthen the case for outside bodies or nongovernmental organizations to press governments to undertake ambitious reforms.
Comparative static exercises also suggest that, other things equal, the range of parameters for which a bad steady state with low growth and widespread corruption exists is wider when productivity is low and the public sector is large. These results are consistent with empirical evidence that, on the basis of indices of corruption produced by rating agencies, richer countries tend to be perceived as having lower corruption (Mauro, 1995), and a widely held view that large public sectors and pervasive government intervention may be associated with greater corruption (Tanzi, 1998). Policies aimed at improving transparency also help curb corruption and improve growth. The remainder of this paper presents the two models and, in Section III, provides a few concluding remarks.
Andvig, Jens C., and Karl Ove Moene, 1990, “How Corruption May Corrupt,” Journal of Economic Behavior and Organization, Vol. 13, pp. 63–76.
Azariadis, Costas, 2001, “The Theory of Poverty Traps: What Have We Learned?” (unpublished; Los Angeles: UCLA), available via the Internet at www.econ.ucla.edu/azariadis/.
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Huang, Peter H., and Ho-Mou Wu, 1994, “More Order Without More Law: A Theory of Social Norms and Organizational Cultures,” Journal of Law, Economics, and Organization, Vol. 10, No. 2, pp. 390–406.
International Monetary Fund, “The IMF’s Approach to Promoting Good Governance and Combating Corruption—A Guide,” available via the Internet at http://www.imf.org/external/np/gov/guide/eng/index.htm.
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Krueger, Anne O., 1993, “Virtuous and Vicious Circles in Economic Development,” American Economic Review, Papers and Proceedings, Vol. 83, No. 2, pp. 351–56.
Matsuyama, Kiminori, 1996, “Why Are There Rich and Poor Countries? Symmetry-Breaking in the World Economy,” NBER Working Paper No. 5697 (Cambridge, Massachusetts: National Bureau of Economic Research).
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Paolo Mauro is Deputy Chief of the Strategic Issues Division in the Research Department of the International Monetary Fund. The author thanks Alberto Alesina, Tito Cordella, Edward Glaeser, Hélène Rey, Andrei Shleifer, Enrico Spolaore, Aaron Tornell, and Yishay Yafeh for helpful comments.
Similarly, political scientists have long recognized that economic variables affect institutional performance (Hibbs, 1973).
A web guide and access point to many publications regarding the IMF’s approach to promoting good governance and other policy initiatives (including the OECD Convention) is available via the Internet at http://www.imf.org/external/np/gov/guide/eng/index.htm.
Wade (1982) provides a classic description of a bureaucracy in which corruption was systemic and bribes were shared among various civil servants at all levels in the hierarchy.
Andvig and Moene (1990) explore the implications of the assumption that the probability a corrupt official will be reported to higher authorities is a decreasing function of the proportion of his colleagues who are also corrupt. See also Cadot (1987), Dawid and Feichtinger (1996), and Huang and Wu (1994).
A somewhat related literature analyzes the broader issue of agents’ choice between directly productive and appropriative activities (see Skaperdas, 1992, and references therein). For example, Skaperdas (1992) considers a two-person game and finds an equilibrium in which neither player invests in weapons, and an equilibrium in which the players engage in conflict.
Putnam (1993) defines “civicness” as the extent to which citizens cooperate rather than free-ride and interact as equals rather than as patrons and clients. He measures “civicness” as a composite index of objective measures such as the number of recreational and cultural associations. He finds this index to be significantly associated with both bureaucratic efficiency and income levels.
More generally, this is an illustration of how various aspects of institutional inefficiency (in this case, corruption and political instability) are mutually reinforcing. This has already been emphasized by Krueger (1993) and De Soto (1989) with respect to corruption and red tape: they argue that corrupt bureaucrats will intentionally introduce new regulations and red tape in order to be able to extract more bribes by threatening to deny permits.
This analysis ignores congestion effects in the theft technology. One might argue that the marginal product of rent seeking ought to be lower, the higher the total amount of theft activity, as the amount of G available for each rent seeker to steal falls when everybody is stealing from G. As long as this effect becomes predominant only at high levels of total theft activity, one may conjecture that the qualitative results of the present analysis would not be affected.
It is assumed that
Barro (1990) shows that it is optimal for the government to set government expenditure to be a constant proportion of output.
The welfare of the representative consumer is monotonie in the growth rate. The expression for welfare can be rearranged so that L affects it only through the growth rate. The proof is the same as for the Barro (1990) model. Thus, higher L unambiguously implies higher welfare.
It can be shown that the growth rate would be a monotonically positive function of L even if the investment rate were exogenously given and constant, because L affects positively the Y/K ratio through mechanisms (a) and (b).
The opposite corner is not locally stable: at L = 0 (where everybody would be dead anyway) the wage is extremely high, and higher than the marginal product of rent seeking, so that people would wish to increase their supply of productive work.
It is assumed that, owing to convex adjustment costs, people can alter their levels of work versus rent-seeking activity only gradually. Therefore, were there to be a change in the total amount of theft activity, individuals would not be able to jump to L = 0 or L = 1 immediately. In a deterministic model, such as the present one, these adjustment costs do not affect the maximization problem.
The model could be extended to analyze the problem of a government choosing the amount of productive expenditure and the amount of expenditure devoted to protecting property rights (e.g., public expenditure on the police force).
All comparative static exercises in this paper are essentially based upon taking simple derivatives. They are omitted for the sake of brevity but are available upon request.
Barro (1990) shows that both a benevolent and a kleptocratic government would choose î = GIY = α. Indeed, in a simple generalization of Barro’s model any relative weights on the utility of the representative consumer and kleptocrats would yield the same optimal size of government (Mauro, 1996).
For the good steady state to exist where τ = α, the following parameter restriction needs to be satisfied: a < 1 – α. This is a rather mild restriction: recall that a is the proportion of resources stolen that one would retain when nobody else is stealing and 1 – α is labor’s share of output resulting from the production function.
Choosing a tax rate higher than α would not help, because it would increase the range of parameters for which a bad steady state exists and reduce the range of parameters for which a good steady state exists.
According to the New York Times (November 8, 1992, sec. 6, p. 31), the administration of former Brazilian President Fernando Collor de Mello is described as a highly complex and efficient system of corruption, “they established goals: by month x, we are going to net $500 million.” According to Wade (1982), each level of the hierarchy in the administration of the irrigation system in South India obtained a fixed percentage of the total bribe. Together with the systematic evidence on the persistence of institutional efficiency, these examples suggest that once a corruption machine is set up, it takes time to change the way it operates.
When a given politician amasses a fortune (by levying τM or more), citizens will realize that this individual is corrupt. According to the New York Times (November 8, 1992), former President Collor de Mello’s acquisition of a palatial residence triggered a corruption scandal in Brazil, which ultimately culminated in Mr. Collor de Mello’s impeachment.
Many international institutions and nongovernmental organizations (NGOs) have emphasized the importance of transparency in fiscal and monetary accounts, and in the conduct of business more generally. See again the IMF’s website. A partial listing of NGOs that have been active in this area includes Transparency International and recent initiatives by Global Witness and Mr. George Soros encouraging multinational corporations (notably oil and other natural resource companies) to publish how much they pay in royalties, taxes, and fees to each country they deal with. While in the model τM is the highest bribe rate an individual politician can get away with, it is likely that this bribe rate would be reduced by policies aimed more generally at improving transparency.
Politicians are assumed to have an endowment in the second period so that their marginal utility of consumption would not be infinite, were they to be ousted. One could assume that both citizens and politicians obtain an endowment (possibly the same) in both periods. The current formulation is chosen merely to simplify notation.
Under certain conditions, politician i would be able to save the government from collapsing by accepting a bribe lower than λ/N and still be better off than by levying τM. However, this would not be a symmetric equilibrium.