Exploring the Connection Between Corruption and Economic Growth

Exploring the Connection Between Corruption and Economic Growth

There is a deep connection between corruption and economic growth. It can have a lasting effect on the allocation of resources. Corruption within the system leads to an unfair allocation of resources. This in turn affects the economic growth of a country. According to the International Monetary Fund, corruption undermines the public’s trust in its government. It also threatens market integrity, distorts competition, and endangers economic development. [1]

The story in Lebanon is no different. In a paper titled ‘Corruption and Economic Growth in Lebanon‘ [2], the authors have tried to examine the relationship. This article summarizes the key observations of the authors.

Before we delve into the findings of the paper, it would be useful to see the theories around the relationship. It appears that a natural starting point for the economic analysis of corruption is to treat it as any other crime and apply to it the standard economic model of crime developed.[3]

According to this model, persons contemplating corruption take into account the expected benefits in the form of bribes. Then the monetary equivalent of these gains with the expected costs in the form of the probability that they will be detected. Following this, monetary sum (or equivalent) of the punishment, such persons should they be convicted.

Background of corruption and economics

The foundational aspects

The authors begin with the 2001 report of the United Nations on Lebanon. This was one of the earliest documents that illustrated starkly the scale of corruption in the Lebanese Institutions and its devastating impact on the economy. By examining the findings of later studies and reports, the authors conclude that in case of Lebanon, corrupt practices are at the core of the political system.

The authors then examine the impact of corruption across cultures. They examine the findings of economists which concludes that corruption aids the economy, increases bureaucracy and results in inefficient policies. The focus is then shifted to examine corruption from the lens of economics. However, the authors conclude that economic models are unsuccessful in quantifying the trade offs between the direct and indirect effects of combating corruption.

Empirical Evidence and Data Analysis

Data Studio
Analysis

The authors have then used a neoclassical model to show that corruption reduces the country’s standard of living as measured by real per capita GDP. The key findings of the authors is that corruption reduces Lebanon’s standard of living as measured by the real GDP per capita. The authors also argue that corruption reduces the effectiveness of the government as it reduces the government expenditure on output. To benefit themselves, government officials are likely to approve public projects at a much higher cost. This leads to inefficiencies in government spending. Corruption also adversely affects productivity. The authors quote Ehrilich [4] to drive home the point:

Corrupt officials spend a substantial amount of time and effort in seeking and accumulating political capital, which is not socially productive, and as a consequence, their productivity is reduced.

Implications on economic growth

Effects on economy

Corruption permeates every layer of the society. It also prohibits the economy from reaching its potential. Through the analysis carried out, the authors demonstrate that corruption reduces the country’s standard of living and increase inefficiencies in government spending. The other side effects of corruption include lower investments, decrease in the human capital productivity, and low economic growth.

The impact on the economic growth can be also demonstrated through the behavior of the private players. Authors note that typically,the private investors would desire returns from any investment. This guides their decision where they anticipate the highest returns to investment with the least variance. When corruption or the anticipation of corruption enters this equation, it brings an element of uncertainty for the the private investors. In such cases, the investors shy away from making the investment. Chances are that the investment will take place in a country with a lower level of corruption.

Impact on the economy of Lebanon

The case in Lebanon

The authors further note that in case of Lebanon too corruption has an adverse effect on the economy through creating increased inefficiencies in the government expenditure. There is empirical evidence to establish that corruption tends to slow down economic growth in Lebanon. According to the authors:

Corrupt officials steer the approval of projects towards particular domestic or foreign enterprises in exchange for bribes, imposing additional costs on the government budget. Important cases of corruption exist also when political agents steer public investments towards their home districts, diverting public funds. In all these cases, the productivity of the government spending is reduced, thereby hampering the growth rate of the country. Widespread corruption in government budgets will not only reduce the rate of return to new public investment, but also affect the rate of return that a country receives from its existing infrastructure. Corruption increases the cost of operations and maintenance in public institutions. This enhances inefficiency in public institutions, and raises the prices of public and social services, potentially increasing inflation rates in countries such as Lebanon, where government spending accounts for a high percentage of its GDP .

According to them, reduced levels of corruption leads to efficient government spending. This in turn promotes higher level of economic growth. The same hypothesis would also hold true for Lebanon.

Conclusion

The road ahead

Through the paper, the authors establish that corruption has reduced Lebanon’s standards of living, investment and human capital productivity. Increased levels of corruption has led to inefficiencies in the government expenditure. This has also made the government less effective.

However,the authors admit that the study has some limitations. For example, for the the index of corruption, which is generated from subjective surveys, together with the small sample size, are the main limitations. Therefore, the authors believe that access to high quality data, together with sophisticated theoretical and econometric simulation models will provide more compelling results.

In conclusion the authors also note that though the results demonstrate that returns to attempts aimed at stemming corruption are significant, the distribution of these returns is beyond the scope of the paper. This could be explored as an avenue of research.

[1] IMF and Good Governance, March 2019, https://www.imf.org/en/About/Factsheets/The-IMF-and-Good-Governance

[2] The paper has been authored by Moe Farida and Fredoun Z. Ahmadi-Esfahani who are associated with University of Sydney.

[3] Does Corruption affect Economic Growth? available at https://scielo.conicyt.cl/scielo.php?script=sci_arttext&pid=S0719-04332012000200005

[4] Bureaucratic Corruption and Endogenous Economic Growth, Journal of Political Economy, Journal of Political Economy , I Ehrilich and T.L Francis

About the author

Financial advisor to UHNWI, private entities, family offices, and companies. Certified Anti-Corruption Manager from The American Anti-Corruption Institute

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