III. The Growth Process - 1

III. The Growth Process

Corruption has its adverse effects not
just on static efficiency but also on investment
and growth. A payment of
bribes to get an investment license
clearly reduces the incentive to invest
(even apart from affecting the composition
of investment, in view of the considerations
of secrecy and uncertainty
alluded to in the previous section). One

might add that in the taxation system of
many countries, negative profits (losses)
can be deducted from taxable investment
income, but there is no corresponding
loss offset in the case of
bribes, so that the latter are particularly
harmful for risk-taking in the context of
innovation.
Similarly, when public resources
meant for building productivity-enhancing
infrastructure are diverted for politicians’
private consumption (cement
for public roads or dams used for luxury
homes) growth rates obviously will be
affected adversely. Another growth effect
follows from the fact that higher
bribes imply declining profitability on
productive investments relative to rentseeking
investments, thus tending to
crowd out the former. As Kevin Murphy,
Shleifer, and Vishny (1993) point
out, there are many reasons why there
are increasing returns to rent-seeking,
so that an increase in rent-seeking lowers
the cost of further rent-seeking relative
to that of productive investment. In
general when there is slow growth the
returns to entrepreneurship (particularly
in production of new goods) fall
relative to those to rent-seeking, and
the ensuing increase in the pace of
rent-seeking activities further slows
down growth. Besides, innovators are
particularly at the mercy of corrupt
public officials, because new producers
need government-supplied goods like
permits and licenses more than established
producers. In any case, as Romer
(1994) has suggested, corruption as a
tax on ex post profits may in general stifle
entry of new goods or technology
which require an initial fixed cost investment.
Some of these growth effects have
been statistically corroborated from
cross-country data. On the basis of corruption
rankings data assembled from
the Business International correspondents7
in 70 countries in the early
1980s, as reported in Table 1 in the Appendix,
Paolo Mauro (1995) finds a significant
negative association between
the corruption index and the investment
rate or the rate of growth (even after
controlling for some other determinants
of the latter, and correcting for a possible
endogeneity bias in the data). A
one-standard-deviation improvement in
the corruption index is estimated to be
associated with an increase in the investment
rate by about 3 percent of
GDP.8 The negative relation seems to
hold even in subsamples of countries
where bureaucratic regulations are reported
to be cumbersome, indicating
that corruption as a way of by-passing
these regulations may not have been
very beneficial.