ABSTRACT The theoretical and empirical debate on the effects of corruption on economic development is unclear.

Available cross-country evidence suggests that the impact of corruption on economic development may be either positive or negative. However, previous empirical literature has begun to explore the corruptiondevelopment relationship at a regional level and the results are promising. This recent interest is surprising, because the international business community may be more interested in regional patterns regarding the impact of corruption on economic development, than at the national level. Developing economies have different cultural and economic characteristics, but they are often plagued by roughly similar levels of corruption. The key question is whether corruption affects economic development differently in developing countries located in different parts of the world. This report deals with the positive effect of corruption on economic development.

Table of contents

1. Introduction 2. Literature Review 3. Research Methodology 4. Results & Discussion 5. Conclusion 6. Bibliography

INTRODUCTION The debate on the effects of corruption on economic activity is unsettled. Some have argued that corruption hurts economic development because it redirects resources in unproductive direction and instills distortions in the economy (Scheifer and Vishny, 1993). For example, Tanzi and Davoodi (1997) identify four channels through which corruption may have an adverse effect on economic growth: higher public investment, lower government revenues, lower expenditures on business operations and maintenance, and lower quality of public infrastructure. On the other hand, some researchers have argued that corruption may be economically desirable in certain circumstances in that it provides a more efficient provision of government services by bypassing inefficient regulations and red tape (i.e., Acemoglu and Verdier, 1998). Recognizing this equivocality, a number of survey articles provide further arguments for the theoretical validity of either view and review related issues regarding the impact of corruption on economic development (Bardhan, 1997; Wei, 1998; Aidt, 2003; Drexer and Herzfeld, 2005). An important characteristic of the empirical studies on the corruptiondevelopment relationship is that the evidence comes from mainly cross-country studies. Surprisingly, there is scant literature at the regional level. International business managers and/or policy makers working at regional levels may be more interested regional, rather than cross-country, evidence. Furthermore, international business scholars are starting to discover important relationships at any level of analysis. Developing economies have different cultural and economic characteristics, but they are often plagued by roughly similar levels of corruption. The key question we address here is whether corruption affects economic development differently in developing countries located in different parts of the world. If evidence indicates that the corruption-economic development link is sensitive to regional data employed, then further research needs to focus more on region specific studies.

LITERATURE REVIEW The impact of corruption on economic activity is studied from many different perspectives. Some scholars investigate the impact of corruption on economic growth, while others study its impact on domestic and/or foreign direct investment. For example, Mauro (1995) identified the impact of corruption and other institutional factors, including the amount of red tape, the efficiency of the judicial system, and variables of political stability, on economic growth using a data set consisting of 67 countries for the period 1980-1983. Running crosscountry regressions, Mauro finds corruption reduces economic growth through lowering private investment and the relationship is robust to controlling for determinants of investment and growth. In a follow up study, Mauro (1996) studied the influence of corruption on investment, economic growth, and government expenditure using cross-country data for 101 countries and regressions for various time periods. Similar to his earlier work, he found corruption to adversely affect economic growth largely by reducing private investment and possibly by altering the composition of government expenditure, specifically by lowering the share of spending on education. Tanzi and Davoodi (1997) investigated the channels through which corruption affected economic growth using cross-country data and regressions during the period of 1980-1995. They found higher corruption causes higher public investment, lower government revenues, lower expenditures on operations and maintenance, and lower quality of public infrastructure. Their evidence also revealed that corruption increases public investment but reduces its productivity. Ehrlich and Lui (1999) investigated the relationship between corruption, government, and economic growth using a panel data which includes 68 countries over the period 1981-1992. They find that changes in both government size and corruption adversely affect the level of per capita income, but not necessarily its long-run growth rate in the more developed countries. Mo (2000) investigated the impact of corruption on economic growth and the channels through which it affects growth using data similar to Mauro(1995). He found that a 1% increase in the corruption level reduces the growth rate by about 0.72% and the most important channel is political instability, accounting for about 53% of the total effect. He also found that corruption lowers the level of human capital and the share of private investment. Blackburn, Bose, and Haque (2005) derive a theoretical relationship between corruption, economic development, and a number of other variables, using a

dynamic general equilibrium model of economic growth. Their model indicated that the relationship between corruption and economic development is both negative and two-way causal. Mendez and Sepulveda (2005) incorporated measures of political freedom as a key determinant of the relationship between corruption and long-run economic growth. Using cross country data and regressions during the period 1960-2000, they found that the type of political regime is an important determinant of the relationship between corruption and economic growth. By restricting the sample to the countries considered to be free and controlling for a number of economic variables, they found a non-linear relationship between corruption and economic growth. Buse and Hefeker (2006) investigated the links among institutions, political risk, and foreign direct investment inflows using both cross-sectional and crosssectional time-series analysis. The sample size covers 83 developing countries during the period 1984-2003. Their findings showed that government stability, internal and external conflict, corruption and ethnic tensions, law and order, democratic accountability of government, and quality of bureaucracy are highly significant determinants of foreign investment inflows. Larsson (2006) discussed why corruption in Russia is more damaging to economic growth than corruption in China is. He argued that three factors, comparative advantage, the organization of corruption, and the nature of rents, determine the impact of corruption on economic growth and can explain why corruption is more devastating in Russia than in China. Most recently, the corruption-growth literature has started to focus on regional levels of analysis. Two papers that are most related to ours are Guetat (2006) and Gyimah-Brempong and Camacho (2006). These studies include regionspecific institutional variables, such as bureaucratic quality and corruption, into cross-country regressions to distinguish the impact of these variables on economic growth at regional levels. More specifically, Guetat (2006) attempted to separate the impact of corruption in MENA countries on growth from other countries including Latin American, Asian and Sub-Saharan Africa by estimating an economic growth model for a sample of 90 countries for the period 1960-2000. He introduced regional dummy variables and used interaction terms between the variables in regressions and the regional dummies to distinguish among the regional-specific effects. The results indicated that corruption deters growth more significantly in MENA countries than Latin American and other countries.

Gyimah-Brempong and Camacho (2006) employed panel data from 61 countries for the period 1980-1998 to examine regional differences in the impact of corruption on economic growth and income inequality in Africa, Asia and Latin America. This was accomplished by introducing regional dummy variables and using interaction terms between the variables in regressions and the regional dummies. Overall, they found a negative impact of corruption on the growth of income per capita and the distribution of income. The largest negative impact of the former was in Africa, while the largest negative effect of the latter was found in Latin America. These two recent studies offer promising new insights and need further refinement and extension.

RESEARCH METHODOLOGY

The data for this report has been collected on secondary data research basis. Various articles on the internet as well as journals and newspapers were of great help in coming to the final conclusion of the report on such an important issue. Articles by highly acclaimed economists and researchers are available as a previous work on the topic of corruption and growth and their interdependence and they shed light on various aspects that have been discussed further in the report. Corruption being a global issue has been studied with the growth level of economies being kept in consideration. The GDPs of developing economies were the biggest criteria the researchers have used for the conclusions and results. Since the topic under discussion leads to a heavy debate, it has been widely acknowledged by both national and international media and thus excerpts from such reports and media findings have also been an essential data source for this report.

RESULTS & DISCUSSION Wide publicity surrounding the statements at the multinational financial institutions' 1996 Annual Meetings by the Managing Director of the International Monetary Fund that governments must demonstrate their intolerance for corruption in all its forms and by the President of the World Bank that the "cancer of corruption" must be dealt with have stimulated renewed interest in the topic. Researchers have begun to look at so-called corruption indices, which are produced by private rating agencies and are typically based on replies by consultants living in the countries to standardized questionnaires. Obviously the replies are subjective, but the correlation between indices produced by different rating agencies is very high, suggesting that most observers agree more or less on ranking countries according to how corrupt they seem to be. The high prices paid to the rating agencies by their customers (usually multinational companies and international banks) constitute indirect evidence that the information is useful and can have tangible economic effects. On the other hand, the judgment of the consultants who produce these indices may be skewed by the economic performance of the countries they monitor. Substandard economic performance by itself does not argue to pervasive corruption, nor is economic success an infallible sign of innocence of corruption. It is therefore important in analyzing the relationship between perceived corruption and economic variables to be cautious about interpreting correlations as cause-effect relationships. An additional drawback of these indices is their failure to distinguish among various types of corruption: highlevel versus low-level corruption or well-organized versus poorly organized corruption. Despite these limitations, the indices provide a wealth of useful information. Since much public corruption can be traced to government intervention in the economy, policies aimed at liberalization, stabilization, deregulation, and privatization can sharply reduce the opportunities for rent-seeking behavior and corruption. Where government regulations are pervasive, however, and government officials have discretion in applying them, individuals are often willing to offer bribes to officials to circumvent the rules and, sad to relate, officials are occasionally tempted to accept these bribes. Identifying such policy-related sources of corruption is obviously helpful in bringing it under control. The following sources have for some time been well known.

* Trade restrictions are the prime example of a government-induced source of rents. If importing a certain good is subject to quantitative restriction (for example, only so many foreign automobiles can be imported each year), the necessary import licenses become very valuable and importers will consider bribing the officials who control their issue. More generally, protecting a home industry (such as plywood manufacturing) from foreign competition through tariffs creates a semi-monopoly for the local industry. Local manufacturers will lobby for the establishment and maintenance of these tariffs and some may be willing to corrupt influential politicians to keep the monopoly going. Studies have shown that a very open economy is significantly associated with lower corruption. In other words, countries tend to be less corrupt when their trade is relatively free of government restrictions that corrupt officials can abuse. * Government subsidies can constitute a source of rents. Studies show corruption can thrive under industrial policies that allow poorly targeted subsidies to be appropriated by firms for which they are not intended. The more such subsidies are available to industries, the higher the corruption index. * Price controls, whose purpose is to lower the price of some good below its market value (usually for social or political reasons), are also a source of rents and of ensuing rent-seeking behavior. Price controls create incentives for individuals or groups to bribe officials to maintain the flow of such goods or to acquire an unfair share at the below-market price. * Multiple exchange rate practices and foreign exchange allocation schemes lead to rents. Some countries have several exchange rates--one for importers, one for tourists, one for investors, for example. Differentials among these rates can lead to attempts to obtain the most advantageous rate, although this rate might not apply to the intended use of the exchange. Multiple exchange rate systems are often associated with anti-competitive banking systems in which a key bank with government ties can make huge profits by arbitraging between markets. Some countries have little foreign currency and distribute what they have through various schemes, with varying degrees of transparency. If, for example, state-owned commercial banks ration scarce foreign exchange by allocating it according to priorities established by government officials, interested parties may be willing to bribe these officials to obtain more than their fair share. * Low wages in the civil service relative to wages in the private sector are a source of low-level corruption. When civil service pay is too low, civil servants may be obliged to use their positions to collect bribes as a way of making ends meet, particularly when the expected cost of being caught is low.

In addition to government regulations as an occasion for corruption, other reasons for corruption have been identified. * Natural resource endowments (oil, gold, exotic lumber) constitute a textbook example of a source of rents, since they can typically be sold at a price that far exceeds their cost of extraction and their sale is usually subject to stringent government regulation, to which corrupt officials can turn a blind eye. Resource-rich economies may be more likely to be subject to extreme rentseeking behavior than are resource-poor countries. * Sociological factors may contribute to rent-seeking behavior. An index of ethnolinguistic fractionalization (societal divisions along ethnic and linguistic lines) has been found to be correlated with corruption. Also, public officials are more likely to do favors for their relatives in societies where family ties are strong. Since most of the above mentioned causes of corruption are related to the corporate sector, we can easily see that the mentioned points slow down the speed of performing or getting a task performed. A high level of control and too much delay in system tends to form an obstacle in front of businessmen, even those who want to be honest, to fall prey to corruption in order to speed up their process. Some say that bribes often work as grease that can speed of wheels of commerce. In a country that is rife with bad and heavy regulations, the opportunity to offer bribes to circumvent bad government control is like deregulation, and hence can be good. Kaufmann and Wei argues that this view is true only in a very narrow sense when the bad regulation and official harassment are taken as exogenous. Officials often have lots of leeway to customize the type and amount of harassment on individual firms. Tax inspectors may have room to over-report taxable income. Fire inspectors can decide how frequently they need to come back to check fire safety in a given year. Using data on a survey of nearly 2400 firms in 58 countries, Kaufmann and Wei show that, even within a country, managers of the firms that pay more bribes on average spend more rather than less time negotiating with government officials. Corruption in the form of bribing can be an important arm in the hands of entrepreneurs seeking to do business with a hostile or indifferent government and may, indeed stimulate the development process. In many developing countries excessive bureaucratic control and regulations creates serious uncertainty for entrepreneurs. So the bribery can help bureaucrats to get around excessive regulations and minimize uncertainty over enforcement.

CONCLUSION Corruption has been around for a very long time and will be around in the future unless governments can figure out effective ways to combat it. This is not going to be easy. Although the study of the causes and consequences of corruption has a long history in economics, going back 30 years to seminal contributions on what economists call rent seeking, related empirical work on quantifying the extent of corruption and putting a dollar sign on its economic effects has been limited. This is hardly surprising since most corruption is clandestine. Also, determining just how efficient government institutions are is not what would be called an exact science. As a consequence, corruption is notoriously hard to measure and empirical economic research on the question is fairly meager. This report focuses exclusively on corrupt public practices--illegal activities that reduce the economic efficiency of governments. It does not address private corruption, such as that practiced on individuals and private enterprises by organized crime.

BIBLIOGRAPHY

http://www.isid.ac.in/~planning/Niloy.pdf http://www.deeshaa.org/2004/11/24/corruption-and-economicdevelopment-a-reference/ http://abs.sagepub.com/content/8/3/8.short

Corruption, institutions, and economic development Oxford Review of Economic Policy June 1, 2009 25: 271-291 Representation, Corruption, and Subjective Well-Being Comparative Political Studies December 1, 2008 41: 1607-1630 Corruption, Optimal Taxation, and Growth Public Finance Review May 1, 2003 31: 207-240

CORRUPTION IS MORALLY BAD BUT ECONOMICALLY BENEFICIAL FOR A NATIONS PROSPERITY

Submitted by:: Anshika Puri