Corruption total economic loss from corruption is in fact

Corruption is
not only a social and political issue – problem that needs to be resolved. It
strongly affects the economy as a whole as it is by and large considered a
strong constraint on growth and development. According to the World Bank, it is
estimated that approximately 1.5 trillion of dollars is paid each year in
bribes by businesses and individuals worldwide while the total economic loss
from corruption is in fact a multiple of that number. It also affects one of
the main channels through economies evolve i.e. foreign investments both public
and private are discouraged in the presence of corruption; however, the extend
depends on the country and its institutions.  Corrupted economies cannot deploy their
financial and human capital which if properly used can both be very powerful
tools for the countries’ development.

It is widely
accepted that corruption has a major impact mainly on emerging and transition
economies which are now more than ever in the centre of economists’ attention.
It is also linked and can affect institutional performance, levels of education
and healthcare. In highly – corrupted countries, poor people are excluded from
health services and this has a negative impact on infant and child mortality,
on children’s health and on health outcomes in general. In countries where
corruption is present, higher – order crimes flourish. It distorts the balances
and the relationships between citizens and the state.

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Based on the
above, economists consider corruption a major obstacle for development and
growth. The World Bank for example, regards corruption a major challenge to its
twin goals of ending extreme poverty by 2030 and boosting shared prosperity for
the poorest 40 percent of people in developing countries.1
The reduction of corruption activities is also at the centre of the Sustainable
Development Goals, goals which include specific targets for the fighting of
corruption, reduction of rent-seeking activities and illicit financial flows.


Literature Review


1.1.   Studying the corruption – growth nexus


The traditional
theory of economic growth deals with the impact of capital accumulation and
technological progress on the growth of economies. The ways in which modern
societies are organized and the institutions that govern them can often
determine the level of well-being of people living in them. The proper and
efficient operation of the above is likely to contribute to technological
development, innovation, the promotion of education and in general the progress
of society in all areas. Instead, and as already mentioned, corruption usually
– if not always – has significant impacts on countries’ economic growth and
development. The misuse of institutions brightens and sustains corruption,
causing severe economic, social and social shocks or as it is widely known in
the literature corruption “sands
the wheels” of economic growth. Therefore, this is the main reason why
economists do care so much about studying the phenomenon of corruption as well
as its association with economic development.

It is commonly
accepted that the literature related to corruption is quite vast. In this
section, a presentation of the most important contributions of research is
going to be reviewed. Shleifers’ studies are considered the cornerstone of the
corruption – related literature. According to Shleifer and Vishny (1993), the level
of corruption is determined by the structural form of both institutions and
political procedures. That’s why less developed countries with weak
institutional quality experience a high level of corruption which in turn has
detrimental consequences for their development. Furthermore, the amount of
bribes increases with the number of independent bureaucrats who act by
promoting their own personal interests. Along these lines, Frey and Shleifer
(1997) described and analysed in detail two models of corruption i.e. the
“invisible hand model” and the “grabbing hand model”. Each one of them can best
fit and describes a different East European economy that was liberalized in the
1990s. Their results show that although the two economies i.e. Poland that is
better described from the first model and Russia that is better described from
the second model adopted the same economic reforms, the Polish economy
experienced a rapid growth while the Russian economy step behind. According to
their findings, a key reason for this difference in development is the
different relationships between the government and firms in the two countries.
In particular, the “invisible hand” leads to a more effective court system in terms
of resolving disagreements and differences not only among private parties
themselves but also between private parties and the government. On the contrary,
the “grabbing hand” makes the county’s government ineffective in providing even
the basic services to provide only basic services, courts are ineffective and
in the extreme, contracts are enforced privately.

The seminal
study of Mauro (1995) investigates the relationship between corruption and
economic growth by examining 67 countries in the period 1960-1985. According to
its results, higher levels of corruption are negatively linked to the average
annual rate of growth. In the same line of research, Mauro (1996) examines the
impact of corruption not only on economic growth but also on investment, as
investment is considered one of the most important channels through which
economic growth is achieved. The sample of countries he uses is now increased
to 106. He is driven to the conclusion that if the index of corruption is
improved, then the average investment rate and the growth rate of per capita
GDP are also improved. Of course, the reverse conclusion is also true.

intervention in economic activity and the consequences of corruption on
economic growth were studied by Ehrlich and Lui (1999) in a sample of 152
states for the period 1960-1992. Their results show that the higher the
involvement of the state and the higher the level of corruption are, the less
economically developed the country will be. The influence of state corruption
and size is found to be smaller in developed countries, indicating a non-linear
relationship between corruption and size government with economic growth.

In line with Mauro (1996), Méon and
Sekkat (2005) observe that corruption is negatively correlated with both growth
and investment levels. Nevertheless, the quality of governance influences the
magnitude of the impact and due to this factor corruption has more severe
consequences in economies where the rule of law is weak enough and their
governmental quality is low. This also holds for countries in which ongoing
conflicts or wars are present.

There is also a strand of the
literature that support the view that corruption has positive effects on
economic development. According to these studies, corruption in some cases may
even have beneficial effects on growth. In other words, and in contrast with
the previous strand of the literature, corruption “greases the
wheels” of countries’ development. The mechanism through which this can be
achieved is that corruption helps economic agents coming mainly from the
private sector to bypass bureaucratic and administrative impediments and unwieldy

Freckleton et
al. (2012) for instance, support that in countries with sticky regulations and
bureaucratic processes which are characterized by inefficiency and delays, corruption
may eventually facilitate the attraction of FDI inflows. As a result, foreign investors don’t have to wain
in queues in order to make an investment. Similarly, Mendez and Sepúlveda
(2006) provide evidence that corruption is advantageous for long-run development
at low levels in countries
which are characterized as “free”.2
However, the authors underline that abnormally prominent levels of
corruption are at the expense of economic growth, regardless the type of
government and the degree
of political freedom.


1.2.   Studying the corruption – foreign aid nexus


Taking the flows of capital from the
richest to the poorest countries and the increase in foreign aid programs aimed
at reducing poverty in developing countries as given, it is important to
investigate their relationship with corruption and development. In developing
countries that receive foreign aid, the existence of corruption may reduce the
effectiveness of this aid, especially if these resources are not addressed to
beneficial investment programs. For example, 70% of public spending in African
countries comes from foreign aid flows. Nonetheless, this continuous flow of
“free” money has created a situation where governments are
inefficient, incentives for entrepreneurship are destroyed and growth and development
are undermined. In other words, these countries are trapped into a vicious
cycle of continuous under-development. The World Bank report on the evaluation
of these programs (1998) highlights that “there is no reason to provide
financial support to countries with poor and bad policies”.


Alesina and Weder (2002) state that
foreign aid programs aim not only at reducing poverty but also in rewarding
good and effective policies and as honest governments. According to the authors,
there is no sufficient evidence to prove that less corrupt governments receive
higher amounts of foreign aid.

Scandinavian countries tend to reward
the least corrupt governments whereas the United States – although in favor of
democratic regimes – seem not to be particularly interested in the quality of
the institutions of the recipient country as they obviously want to command and
control such countries. In addition, the increase in foreign aid levels leads
to increased corruption, a phenomenon known in the literature as “the
influence of greed”.


Analyzing the channels through which
corruption influences development, de la Croix and Delavallade (2014) find that
the most corrupt recipients finally receive much foreign aid. However, these
countries are poor and developing economies usually poor with low institutional
quality and productivity.












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