Corruption and economic growth: Theory and international evidence

The issue of corruption and its effect on the economy has received a great deal of recent attention in the economics literature, as well as in the news media. However, there is no consensus on the dynamics of this phenomenon vis-á-vis economic growth. Toward that end, this thesis develops a neoclassical economic growth model with corruption as an exogenous variable affecting multifactor productivity. In the model, corruption reduces a country's output per worker as well as economic growth,; Using a corruption index and national accounting data for a cross-section of countries, the results of exhaustive regression analyses corroborate the model. Regressions consistently show a negative and statistically significant effect of corruption on output per worker. These findings are robust across samples, even when controlling for various economic and political variables. A linear and elastic relationship exists between the corruption index and output per worker—a one-percent increase in corruption decreases output per worker by 1.57 percent. The results also suggest a nonlinear negative effect of corruption on output per worker for the OECD sample.; A test of the economic growth specification using the full sample and a non-OECD sample reveal that corruption has a linear and negative effect on economic growth, as well. However, the results for the OECD sample reveal a nonlinear concave effect of corruption on economic growth. Initially, an increase in the level of corruption aids economic growth—but it does so in a decreasing way. As corruption becomes more pervasive, it retards economic growth. Empirical evidence suggests that the optimal level of corruption for the OECD countries is 4.88 on a scale of 0 to 6.; The thesis develops and tests a physical capital accumulation model. Consistent with the effect on output, the results suggest that corruption deter the capital accumulation process as well. A strong negative relationship is observed for the full sample and as the economic growth model suggests, there is a nonlinear effect on capital accumulation for the OECD sample. Causality is explored using the Granger method. The results support the hypothesis that corruption causes lower economic growth but only for the OECD sample. Reverse causality is weakly established but cannot be ruled out.