E C O N O M I C I S S U E S 6

Why Worry About Corruption?

Paolo Mauro

I N T E R N A T I O N A L M O N E T A R Y F U N D
W A S H I N G T O N , D . C .

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 ©1997 International Monetary Fund

ISBN: 1-55775-635-X
Published February 1997

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Preface

The Economic Issues series was inaugurated in September 1996.

Its aim is to make available to a broad readership of nonspecialists
some of the economic research being produced in the International
Monetary Fund on topical issues. The raw material of the series is
drawn mainly from IMF Working Papers, technical papers produced
by Fund staff members and visiting scholars, as well as from policy-
related research papers. This material is refined for the general read-
ership by editing and partial redrafting.
The following paper draws on material originally contained in
IMF Working Paper 96/98, “The Effects of Corruption on Growth,
Investment, and Government Expenditure,” by Paolo Mauro, then
an economist in the IMF’s Policy Development and Review
Department. David D. Driscoll of the Fund’s External Relations
Department prepared the present version. Readers interested in the
original Working Paper may purchase a copy from IMF Publication
Services (price $7.00).

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Why Worry About Corruption?

C orruption has been around for a very long time and will be
around in the future unless governments can figure out effec-
tive ways to combat it. This is not going to be easy. Although the
study of the causes and consequences of corruption has a long his-
tory in economics, going back 30 years to seminal contributions on
what economists call rent seeking (see box), related empirical
work on quantifying the extent of corruption and putting a dollar
sign on its economic effects has been limited. This is hardly sur-
prising 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 notori-
ously hard to measure and empirical economic research on the
question is fairly meager. This paper focuses exclusively on corrupt
public practices—illegal activities that reduce the economic effi-
ciency of governments. It does not address private corruption, such
as that practiced on individuals and private enterprises by orga-
nized crime.
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

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 Rent and Rent Seeking
For most of us, rent is what we pay the landlord each month or what
a rental agency at an airport charges for letting us use a car for a week.
For the economist, however, rent is short for “economic rent” and
means something quite different. It is the extra amount paid (over what
would be paid for the best alternative use) to somebody or for some-
thing useful whose supply is limited either by nature or through human
ingenuity. For example, Mike Tyson, the boxing champion, has a nat-
ural and rare talent for flooring his opponents during the first round
and he was paid some $70 million for exercising this talent during 1996.
If he were not a talented boxer, Mr. Tyson’s alternative employment
would likely be somewhat more modest, earning, say, about $30,000 a
year. The $69,970,000 difference is an economic rent accruing to Mr.
Tyson because nature has seen to it that boxers of his skill are in very
short supply. Similarly, for several years during the 1980s the U.S. gov-
ernment restricted the import of Japanese automobiles to a certain
quota, creating an artificial shortage of foreign cars. The result? General
Motors and other U.S. car manufacturers not only sold more cars but
raised their prices, thereby enjoying an economic rent (the difference
between the price of domestic cars and the cheaper but unavailable
Japanese alternative). Japanese auto manufacturers also enjoyed an
economic rent because the demand for their cars in the United States
outstripped the artificially low supply.
Not much can be done about natural limitations on supply, for
which Mr. Tyson is no doubt grateful, but seeking economic rents by
creating artificial limitations is a booming business. Two centuries ago
Adam Smith noted that “People of the same trade seldom meet
together, even for merriment and diversion, but the conversation ends
in a conspiracy against the public.” Every day private firms spend vast
amounts of money attempting to convince legislators to grant monop-
olies or otherwise restrict competition so that some industry or indi-
vidual can realize a rent. Throughout the world bureaucrats and peo-
ple in authority are indefatigably maneuvering to position themselves
in a tiny monopoly where they can be bribed for issuing a license,
approving an expenditure, or allowing a shipment across a border.
Studies have shown that these rent-seeking activities exact a heavy
economic and social toll. Some rent-seeking activities are perfectly
legal. Other rent-seeking activities listed in this paper are distinctly ille-
gal, and it goes without saying that society would be better off with-
out their corrupting influence.

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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 standard-
ized 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 eco-
nomic effects. On the other hand, the judgment of the consultants
who produce these indices may be skewed by the economic per-
formance of the countries they monitor. Substandard economic per-
formance 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: high-level versus low-level corruption or well-organized
versus poorly organized corruption. Despite these limitations, the
indices provide a wealth of useful information.
This paper has two goals. First, it lists a number of possible causes
and consequences of corruption, derived from a review of recent
empirical studies that use cross-country regressions to determine the
strength of the links between corruption and its causes and conse-
quences. (A regression is a statistical technique for estimating the
equation that best fits sets of observations. In this case, regressions
point to the most probable causes and the most probable conse-
quences of corruption.) Although data limitations subject empirical
work to many uncertainties, these studies provide tentative evidence
that corruption may seriously inhibit economic performance.
Second, the paper presents recent evidence on the extent to which
corruption affects investment and economic growth and on how it
influences governments in choosing what to spend their money on.
It finds that corruption discourages investment, limits economic

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growth, and alters the composition of government spending, often
to the detriment of future economic growth.

Causes of Corruption

Since much public corruption can be traced to government inter-

vention in the economy, policies aimed at liberalization, stabilization,
deregulation, and privatization can sharply reduce the opportunities
for rent-seeking behavior and corruption. Where government regula-
tions are pervasive, however, and government officials have discre-
tion in applying them, individuals are often willing to offer bribes to
officials to circumvent the rules and, sad to relate, officials are occa-
sionally 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 automo-
biles can be imported each year), the necessary import licenses
become very valuable and importers will consider bribing the offi-
cials 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 politi-
cians 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.

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 • 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 indus-
tries, 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 exam-
ple, 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 pri-
vate 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 corrup-
tion, 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,

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to which corrupt officials can turn a blind eye. Resource-rich
economies may be more likely to be subject to extreme rent-seek-
ing 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 cor-
ruption. Also, public officials are more likely to do favors for their
relatives in societies where family ties are strong.

Consequences of Corruption

Among the many disagreeable aspects of corruption is evidence

that it slows economic growth through a wide range of channels.
• In the presence of corruption, businessmen are often made
aware that an up-front bribe is required before an enterprise can be
started and that afterwards corrupt officials may lay claim to part of
the proceeds from the investment. Businessmen therefore interpret
corruption as a species of tax—though of a particularly pernicious
nature, given the need for secrecy and the uncertainty that the bribe-
taker will fulfill his part of the bargain—that diminishes their incen-
tive to invest. Empirical evidence suggests that corruption lowers
investment and retards economic growth to a significant extent.
• Where rent seeking proves more lucrative than productive
work, talent will be misallocated. Financial incentives may lure
the more talented and better educated to engage in rent seeking
rather than in productive work, with adverse consequences for the
country’s growth rate.
• Of particular relevance to developing countries is the possibil-
ity that corruption might reduce the effectiveness of aid flows
through the diversion of funds. Aid, being fungible, may ultimately

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help support unproductive and wasteful government expenditures.
Perhaps as a result, many donor countries have focused on issues of
good governance, and in cases where governance is judged to be
especially poor, some donors have scaled back their assistance.
• When it takes the form of tax evasion or claiming improper tax
exemptions, corruption may bring about loss of tax revenue.
• By reducing tax collection or raising the level of public expen-
diture, corruption may lead to adverse budgetary consequences.
It may also cause monetary problems if it takes the form of improper
lending by public financial institutions at below-market interest
rates.
• The allocation of public procurement contracts through a cor-
rupt system may lead to lower quality of infrastructure and pub-
lic services.
• Corruption may distort the composition of government
expenditure. Corruption may tempt government officials to choose
government expenditures less on the basis of public welfare than on
the opportunity they provide for extorting bribes. Large projects
whose exact value is difficult to monitor may present lucrative
opportunities for corruption. A priori, one might expect that it is eas-
ier to collect substantial bribes on large infrastructure projects or
high-technology defense systems than on textbooks or teachers’
salaries.

Description of the Data

This paper uses indices of corruption drawn from two private firms:
1. Political Risk Services, Inc., which publishes the International
Country Risk Guide. This paper uses an index, compiled by the IRIS

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Center of the University of Maryland, which is based on averages for
1982–95 and is available for over 100 countries.
2. Business International (now incorporated into The Economist
Intelligence Unit). The index used here is based on averages for
1980–83 and is available for 67 countries.
Both indices are on a scale from 0 (most corrupt) to 10 (least cor-
rupt). The corruption index used in this paper is the simple average
of both indices, which report remarkably similar judgments on indi-
vidual countries.
The paper also uses three standard sources of data on the com-
position of government expenditure:
1. The Barro (1991) data set containing the 1970–85 averages of
government spending on defense, education, social security and wel-
fare, public investment, and total government expenditure for over
100 countries. This data set provides the basis for much recent empir-
ical work on the determinants of economic growth. (See Robert J.
Barro, 1991, “Economic Growth in a Cross Section of Countries,”
Quarterly Journal of Economics, Vol. CVI (May), pp. 407–43).
2. The Devarajan (1993) data set of developing countries, to
which the industrial countries were added, so as to obtain a sample
of around 95 countries. The data refer to 1985 observations. The
components of expenditures on education (school, university, and
other education) and health (hospitals, clinics, and other institu-
tions) are available for about 60 countries. (See Shantayanan
Devarajan, Vinaya Swaroop, and Heng-fu Zou, 1996, “The
Composition of Public Expenditure and Economic Growth,” Journal
of Monetary Economics, Vol. 37 (April), pp. 313–414.)
3. The Easterly and Rebelo (1993) data set, which consolidates the
public investment expenditure of the general government with public
investment expenditures undertaken by public enterprises for 96
countries. It provides data on the composition of public investment by
sector for about 40 countries. (See William Easterly and Sergio Rebelo,
1993, “Fiscal Policy and Economic Growth: An Empirical Investigation,
Journal of Monetary Economics, Vol. 32 (December), pp. 417–58).

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Empirical Results

This section analyzes further how corruption affects investment

and economic growth and reports new evidence on the relationship
between corruption and the components of government expendi-
ture.

Effects of Corruption on Investment and Economic Growth

Regression analysis indicates that the amount of corruption is neg-
atively linked to the level of investment and economic growth, that
is to say, the more corruption, the less investment and the less eco-
nomic growth. Analysis further shows that if the corruption index
improves by one standard deviation (equal to 2.38 in this case—a
standard deviation measures variation from the “normal” index), the
investment rate increases by more than 4 percentage points and the
annual growth rate of per capita GDP increases by over a half per-
centage point. In effect, a country that improves its standing on the
corruption index from, say, 6 to 8 (recall that 0 is most corrupt, 10
least), will enjoy the benefits of an increase of 4 percentage points
of investment, with consequent improvement in employment and
economic growth.

Corruption and Government Expenditure

When they have the option, do corrupt politicians choose gov-
ernment projects on which it is easier to levy bribes rather than
those that promise the greatest public good? Does the greed of cor-
rupt politicians affect to any significant degree the composition of
government expenditure? If corruption acted simply as an equal tax

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on all government expenditure (if, say, 10 percent of the cost of all
government expenditures is raked off in bribes), the composition of
this expenditure would be independent of corruption. Whether a
dam is built or an equally costly squadron of jet fighters purchased
would make no difference to politicians, who would derive the
same rent from each option. They could afford to act in the public
interest. In the real world, however, it seems reasonable to interpret
any empirical relationship between corruption indices and particu-
lar components of government spending as tentative evidence that
bribes can be more readily collected on some types of government
expenditure than on others.
The question whether corruption affects the composition of gov-
ernment expenditure is an interesting one to consider because, even
though the empirical literature has so far yielded mixed results on
the effects of government expenditure and its composition on eco-
nomic growth, most economists think that the level and type of
spending undertaken by governments do matter for economic per-
formance. Fairly robust evidence suggests, for example, that high
rates of enrollment in schools are related to superior economic
growth. Is there evidence that corrupt governments may display
predatory behavior in choosing the composition of government
expenditure? Specifically, is government spending on education
negatively affected by corruption?
Statistical analysis of the data sources identified in this paper in
fact shows that government spending on education as a ratio to
GDP is negatively and significantly correlated with corruption (the
more corruption, the less spent on education). Analysis also shows
that if a country moves up the corruption index from, say, 6 to 8 (it
improves its respectability by one standard deviation), government
spending on education increases by around a half a percent of GDP.
Although similar analysis indicates that other components of
government expenditure, most notably transfer payments (social
insurance and welfare payments), are also negatively and signifi-
cantly associated with the corruption index, education turns out to
be the only component of public spending that remains signifi-
cantly associated with corruption when the level of per capita
income in 1980 is used as an additional explanatory variable. (This

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control takes into account the well-known empirical observation
that government expenditure as a percentage of GDP tends to rise
as a country becomes richer—a relationship known as Wagner’s
law.) Surprisingly, government spending on defense or transporta-
tion displays no significant relationship with corruption. This does
not mean that spending on these items is entirely free of corrup-
tion, but only that simple statistical analysis does not find any sig-
nificant evidence that it is.
It is possible to speculate that, while bribes are difficult to levy on
teachers’ salaries, they are easier to levy on the construction of school
buildings and other capital expenditures. Most people suspect that
corruption leads to high capital expenditure on “white elephant” pro-
jects (grandiose presidential palaces, unnecessarily large airports, or
vast university campuses). The data used in this paper do not provide
significant evidence to support this suspicion, although an improve-
ment in the corruption index seems to be associated with an increase
in current expenditure as a ratio to GDP and with a decrease in cap-
ital expenditure, where white elephants are born. While evidence is
fairly robust that corruption lowers total (public and private) invest-
ment, no clear relationship has been found between corruption and
public investment. A possible explanation of this finding is that
predatory behavior by corrupt governments may help sustain the
level (though perhaps not the quality) of public investment as a ratio
to GDP, even as private investment declines.

Direction of Causality

While, for the sake of clarity of exposition, the above review

boldly calls variables suspected of being related to corruption either
a cause or an effect of that corruption, the direction of causality is
not entirely evident in all cases. For example, it is not always clear

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whether the existence of government building regulations causes
bureaucrats to ask for bribes in return for helping construction firms
circumvent them, or whether these regulations were created by cor-
rupt bureaucrats seeking a means of realizing economic rents.
Although some attempt has been made to establish the correct direc-
tion of causal links, the issue of causality remains unresolved, and it
is possible that variables may occasionally act simultaneously as
both cause and effect. Fortunately, however, policy conclusions do
not entirely depend on definitively establishing the direction of
causality. An observed correlation between corruption and the com-
position of government spending may be sufficient grounds to con-
sider encouraging governments to allocate a larger proportion of
their spending to those items that are less susceptible to corruption.

Concluding Remarks

This paper has analyzed a number of causes and consequences

of public corruption. It has provided a synthetic review of recent
studies that estimate empirically some of these links. In addition,
though data limitations imply that the results must be interpreted
with caution, it has presented evidence that corruption may have
considerable adverse effects on economic growth, largely by reduc-
ing private investment, and perhaps by worsening the composition
of public expenditure. The paper has presented evidence of a neg-
ative and significant relationship between corruption and govern-
ment expenditure on education, which is a reason for concern since
previous literature has shown that educational attainment is an
important determinant of economic growth. A possible interpreta-
tion of the observed correlation between corruption and the com-
position of government expenditure is that corrupt governments
find it easier to collect bribes on some expenditure items than on
others.

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 The Economic Issues Series

1. Growth in East Asia: What We Can and What We Cannot Infer.

Michael Sarel. 1996.

2. Does the Exchange Rate Regime Matter for Inflation and

Growth? Atish R. Ghosh, Anne-Marie Gulde, Jonathan D. Ostry,
Holger Wolf. 1996.

3. Confronting Budget Deficits. 1996.

4. Fiscal Reforms That Work. C. John McDermott and Robert F.

Wescott. 1996.

5. Transformations to Open Market Operations: Developing

Economies and Emerging Markets. Stephen H. Axilrod. 1996.

6. Why Worry About Corruption? Paolo Mauro. 1997.

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Paolo Mauro is an economist in the European I
Department of the International Monetary Fund.
He graduated from Oxford University and received
a Ph.D. from Harvard University.

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