UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM-NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS EFFECTS OF CORRUPTION ON ECONOMIC GROWTH THROUGH TRANSMISSION CHANNELS IN DEVELOPING COUNTRIES By NGUYEN NINH QUOC TRAN MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, JULY 2013 A TIEU LUAN MOI download : skknchat@gmail.com UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM-NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS EFFECTS OF CORRUPTION ON ECONOMIC GROWTH THROUGH TRANSMISSION CHANNELS IN DEVELOPING COUNTRIES A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By NGUYEN NINH QUOC TRAN Academic supervisor Dr. NGUYEN TRONG HOAI HO CHI MINH CITY, JULY 2013 B TIEU LUAN MOI download : skknchat@gmail.com ABSTRACT This paper examines direct and indirect effects of corruption on economics growth in developing countries. Indirect effects of corruption on economic growth will be examined by five transmission channels such as government size, capital investment, trade openness, human capital, and political instability. With 35 developing countries in data set and OLS, 2SLS method, the result is that corruption has positive relationship with government expenditure, trade openness, human capital, and political instability.
That means more corruption will make more government expenditure, trade openness, human capital, and political instability. However corruption only relates negatively with capital investment. And through the effects of these transmission channels on economic growth, we can infer that totally corruption has positive relationship with economic growth. The result in this paper is also an evidence of “grease the wheel” hypothesis in developing countries.
This is like a careful remind on the policy of fighting against corruption because in developing countries a characteristic of corruption is positively related with economic growth. Keywords: Corruption, economic growth, government expenditure, capital investment, openness, human capital, political instability. i TIEU LUAN MOI download : skknchat@gmail.com TABLE OF CONTENTS ABSTRACT. 7 CHAPTER 2: LITERATURE REVIEWS .1- CONCEPT OF corruption .1- Corruption greases the wheels of growth .2- Corruption is sand of the wheels of growth.
10 CHAPTER 3: CONCEPTUAL FRAMEWORK. 20 CHAPTER 4: METHODOLOGY AND DATA SOURCE .1- DIRECT EFFECT OF CORRUPTION AND TRANSMISSION CHANNELS ON GROWTH .2- INDIRECT EFFECTS OF CORRUPTION ON GROWTH THROUGH TRANSMISSION CHANNELS. 24 ii TIEU LUAN MOI download : skknchat@gmail.3- TOTAL EFFECT OF CORRUPTION ON GROWTH. 25 CHAPTER 5: RESEARCH FINDINGS IN DESCRIPTIVE STATISTIC ANALYSIS.1- RELATIONSHIP BETWEEN TRANSMISSION CHANNELS AND GROWTH .2 RELATIONSHIP BETWEEN CORRUPTION AND TRANSMISSION CHANNELS AND EFFECT OF CORRUPTION ON GROWTH.
32 CHAPTER 6: REGRESSION ANALYSIS .1- DIRECT EFFECT OF CORRUPTION ON GROWTH AND EFFECTS OF TRANSMISSION CHANNELS ON GROWTH.2- EFFECTS OF CORRUPTION ON TRANSMISSION CHANNELS AND GROWTH .1- Effect of corruption on government expenditure .2- Effect of corruption on capital investment .3- Effect of corruption on openness .4- Effect of corruption on human capital .5- Effect of corruption on political instability.3- TOTAL EFFECT OF CORRUPTION ON GROWTH. 52 CHAPTER 7: CONCLUSION REMARKS. 61 iii TIEU LUAN MOI download : skknchat@gmail.com ABBREVIATION OLS: Ordinary Least Square 2SLS: Two Stages Least Square CI: Corruption Perceptions Index EEPC: Engineering Enrolment Per Capita iv TIEU LUAN MOI download : skknchat@gmail.com LIST OF TABLE Table 2.1: Summary of literature reviews…………………………………………….1: OLS of transmission channels and corruption on growth……………….2: 2SLS of gGX-CI……………………………………….3: 2SLS of gFC-CI…………………………….4: OLS of gFC-CI…………………………….5: 2SLS of gTT-CI…………….6: 2SLS of EEPC-CI…………….7: 2SLS of PI-CI………….51 v TIEU LUAN MOI download : skknchat@gmail.com LIST OF FIGURES Figure 3.1: Effect of corruption on transmission channels and economic growth.1: Scatter graph between g and gFC………….2: Scatter graph between g and gGX…………………………….3: Scatter graph between g and gTT……………….4: Scatter graph between g and PI………….5: Scatter graph between g and EEPC……………………………………….6: Scatter graph between CI and gGX……………………………………….7: Scatter graph between CI and gFC…….8: Scatter graph between CI and gTT….9: Scatter graph between CI and gTT (dropping out two outliner points).10: Scatter graph between CI and PI….11: Scatter graph between CI and EEPC….12: Scatter graph between CI and g…………………………………………39 vi TIEU LUAN MOI download : skknchat@gmail.com CHAPTER 1: INTRODUCTION 1.1- RESEARCH CONTEXT Till now there is not the answer about the exact effects of corruption on economic growth. The literatures have not come to one final agreement about the corruption on economic growth yet.
In early time, some authors argued that with an appropriate level of corruption, it can make benefit for economic growth. In the case of rigid government administration, corruption can act as the “grease” to make smooth for economic operation. Without corruption, people or enterprises may have to “queue in line” and waste a lot of time to have the final ideas from the government. And the government also spends more labor force to deal with this situation.
Or like another argument on benefit of corruption, Acemoglu and Verdier (1998) showed that the cost for ensuring the government officials absolutely clean from corruption can be higher than the price of corruption. Lui (1985) established “equilibrium queuing model of bribery” to examine the effect of bribery. With this model, bribes can reduce the cost related with queuing. Through that it improves the efficiency of public administration.
Moreover Beck and Maher (1986) also showed that bribery model would be “isomorphic” with bidding model in supplying goods and services to the government. That means “in the absence of penalties for bribery, supplier firms would be indifferent between bribery and bidding institutions.” On the side of against the corruption, many empirical researches have come to the results that corruption was the “sand” for the wheels of economic operation. In contrast of the idea of corruption is the “grease” for economic operation in rigid government administration, the corruption can make much more delays in administration to attract 1 TIEU LUAN MOI download : skknchat@gmail.com more bribes. The government officials do not want to act quickly because they want to have more time and force the people or enterprises spend more bribes to them.
With this behavior the officials have tendency to give out their decisions basing on the price of corruption. The enterprises with better quality but without corruption will have the disadvantaged decision from the authorized officials. So a good project may come to an inability enterprise. The benefit from this project can be destroyed by this enterprise.
So by corruption, effective allocation in economic has been made distortion. This will have the negative effects on economic growth. Moreover on the side of against the corruption, there are the ideas that corruption reduces the investment. With corruption, the cost of project can become higher.
So this can drop out the good projects and reduce the investment. Reduced investment will affect negatively to economic growth. So until now we really look corruption like the impediment to the economic growth. The report from World Bank in 1998 has seen corruption like the great obstacle to economic and social development.
However we does not still have enough the exactly theoretical framework to definitely confirm the impacts of corruption on economic growth. We have the empirical researches to find out the effects of corruption in the specific cases with different methodologies. Mauro (1995) showed that corruption reduced investment. However investment is a main source of economic growth.
So corruption lowered economic growth through reducing investment. As in Mauro (1995) corruption and growth (also investment) had negative relationship and significant in aspect of statistic and “in an economic sense”. Tanzi and Davoodi (1997) conducted the research about “corruption, public investment and growth”. With cross- section data of countries and regression method they found that more corruption made more public investment and lower government revenues.
Also higher corruption made “lower operation and maintenance expenditures” and “lower quality of public 2 TIEU LUAN MOI download : skknchat@gmail. Also in this paper the authors showed that corruption lowered productivity of public investment (however increased public investment). So that led to negative impact of public investment on economic growth. Finally corruption had negative impact on economic growth.
Kaufmann and Wei (1999) had a research on “grease money”. With data at firm level from worldwide, the authors found conclusion against “efficient grease” hypothesis. They found that paying more bribes does not lead to reduce “management time wasted with bureaucrats” and cost of capital. However paying more bribes would create more “management time wasted with bureaucrats” and more cost of capital.
This would affect investment projects and economic growth in general. Beside the direct impact of corruption on economic growth, recent researches have shown out the indirect impacts of corruption on growth. In summary, we can list out five popular channels such as human capital, capital investment, government size, trade openness, and political instability through which corruption affect economic growth. About human capital channel, Murphy, Shleifer, and Vishny (1991) found that corruption affected how people invest in human capital.
If rent seeking rewards more than producing operation, people will devote most ability to become rent seeker and choose occupation that bring them more rent seeking, not for production. Investment in human capital in this case will be reduced; production of nation will be lowered. Finally it will reduce growth. About capital investment, Mauro (1995) showed the negative relationship between corruption and private investment.
Corruption adds more cost for investment. So it reduces private investment. However investment is the main source of growth. Lower investment will lower economic growth.
Mo (2000) also found corruption had negative 3 TIEU LUAN MOI download : skknchat@gmail.com impact on private investment channel. And through impact on this channel it reduced economic growth. Tanzi and Davoodi (1997) examined the impact of corruption on public investment. Public expenditure had tendency to become bigger under corruption.
Corruption made public investment increase but its productivity decrease. On net effect, it reduced economic growth. However according to Hodge, Shankar, Rao, and Duhs (2009) corruption reduced government spending. On total effect, corruption fosters growth through this channel by lowering government spending.
So we have mixed impact of corruption on government size. Corruption can decrease or increase government spending. About trade openness, one of the ways that the corruption affects trade is quota of exporting and importing. By that way corruption can restrict trade openness.
Pellegrini and Gerlagh (2004) found negative relationship between corruption and trade openness. And final impact of corruption on growth through this channel was negative. Finally corruption affects growth through political instability channel. Corruption can create the ideas about inequality and impropriety among citizens.
This is the root of political instability. And political instability makes bad environment for investment and economy. It will impede economic growth. Mo (2000) examined the indirect impact of corruption on growth through political instability.
He found that corruption had positive relationship with political instability. More corruption will be more instability. And this will lead to lower growth. Pellegrini and Gerlagh (2004) also came to the same result as Mo (2000) about the impact of corruption on political instability and economic growth.
Looking closer on impact of corruption in developing countries, till now we have very few researches about it. Almost researches here have used data of cross countries all 4 TIEU LUAN MOI download : skknchat@gmail.com over the world to find out the impact of corruption on economic growth (indirect and direct impact). According to these researches, corruption has mostly had negative relationship with growth. That means the countries with higher corruption will suffer lower growth.
However this is still right if we look into group of developing countries? Corruption makes more cost for the economy and impedes economic growth. If this is still right for developing countries, corruption will become the great obstacle for development in developing countries. However we may have the argument when we look separately in some developing countries. For example, Indonesia and Thailand have had fast pace of growth in spite of high corruption in these countries.
South East Asia has also experienced fast growth although corruption in most countries of this area is very popular. So in this case corruption has promoted economic growth.