Corruption and human development

TL;DR: Tanzi and Davoodi as discussed by the authors argue that corruption is a symptom of deep institutional weaknesses and leads to inefficient economic, social, and political outcomes, and that it has a damaging impact on efficiency.

Abstract: Corruption, defined as the misuse of public power (office) for private benefit, is most likely to occur where public and private sectors meet. In other words, it occurs where public officials have a direct responsibility for the provision of a public service or application of specific regulations (Rose-Ackerman 1997: 31). Corruption tends to emerge when an organization or a public official has monopoly power over a good or service that generates rent, has the discretionary power to decide who will receive it, and is not accountable (Klitgaard 1988: 75). Corruption's roots are grounded in a country's social and cultural history, political and economic development, bureaucratic traditions and policies. Tanzi (1998) argues that there are direct and indirect factors that promote corruption. Direct factors include regulations and authorizations, taxation, spending decisions, provision of goods and services at below market prices, and financing political parties. On the other hand, quality of bureaucracy, level of public sector wages, penalty systems, institutional controls, and transparency of rules, laws, and processes are the indirect factors that promote corruption. Corruption is a symptom of deep institutional weaknesses and leads to inefficient economic, social, and political outcomes. It reduces economic growth, retards long-term foreign and domestic investments, enhances inflation, depreciates national currency, reduces expenditures for education and health, increases military expenditures, misallocates talent to rent-seeking activities, pushes firms underground, distorts markets and the allocation of resources, increases income inequality and poverty, reduces tax revenue, increases child and infant mortality rates, distorts the fundamental role of the government (on enforcement of contracts and protection of property rights), and undermines the legitimacy of government and of the market economy. There are two opposing approaches in the literature on corruption, regarding the impact of corruption: efficiency enhancing and efficiency reducing. Advocates of the efficiency-enhancing approach, like Left (1964), Huntington (1968), Friedrich (1972), and Nye (1967) argue that corruption greases the wheels of business and commerce and facilitates economic growth and investment. Thus, corruption increases efficiency in an economy. Advocates of the efficiency-reducing approach, like McMullan (1961), Krueger (1974), Myrdal (1968), Shleifer and Vishny (1998), Tanzi and Davoodi (1997), and Mauro (1995) claim that corruption slows down the wheels of business and commerce. Consequently, it hinders economic growth and distorts the allocation of resources. As a result, it has a damaging impact on efficiency. In recent years, especially after 1995, there have been numerous empirical studies about the impact of corruption. A summary of these empirical studies is reported in Table 1. Viewing corruption as an illegal tax, Vinod (1999: 601) estimates that a corrupt act worth $1 imposes a $1.67 burden on the economy. Mauro (1996), Ades and Di Tella (1997), and Tanzi and Davoodi (1997) find a negative relationship between investments and corruption. Mauro (1996), Leite and Weideman (1999), Tanzi and Davoodi (2000), and Abed and Davoodi (2000) find a negative association between real per capita GDP growth and corruption. Mo (2001) investigates the relationship between corruption and economic growth (GDP growth). His empirical analysis reveals that a 1 percent increase in the corruption level reduces the growth by about 0.72 percent. Examining the impact of corruption on foreign direct investment (FDI), Wei (2000), Drabek and Payne (1999), and Habib and Zurawieki (2001) find that corruption is a deterrent factor for foreign investors. Al-Marhubi (2000) investigates the relationship between inflation and corruption and finds a positive relationship. Bahmani-Oskooee and Nasir (2002) analyze the impact of the corruption on real exchange rate. …