The Surprising Relationship Between Corruption and Economic Growth

Posted By Park MacDougald   Tuesday, July 16, 2013 - 7:45 PM

Foreign Policy

Another day, another ballooning corruption scandal in southern Europe. On Monday, the former treasurer of Spain's ruling center-right Popular Party (PP), Luis Bárcenas, admitted in court to authoring handwritten ledgers detailing the secret flow of cash from private firms to top-level officials in the PP. Bárcenas also alleged, after months of speculation in the media, that Spanish Prime Minister Mariano Rajoy accepted regular payments from the illegal slush fund.

A day after Bárcenas's damning testimony, the opposition Socialist Party has threatened to call a vote of no-confidence against the prime minister -- a symbolic gesture given the PP's dominant parliamentary majority. And while it's unclear whether the scandal will bring down Rajoy's government, it has played into the common narrative these days about the connection between government corruption and economic stagnation in Europe's periphery. As the BBC notes, the revelations in Spain "have enraged a country in the depths of recession and record unemployment."

But just what is the relationship between malfeasance and economic performance? The answer might surprise you.

Corruption is certainly widespread in southern Europe. According to Transparency International's Global Corruption Barometer 2013, perceptions of corruption and faith in government institutions are on the rise in the region, with 83 percent of respondents in Greece, 70 percent in Italy, and 66 percent in Spain claiming that "government is run by a few big interests." Conversely, few believe their governments are effective in fighting graft, and many blame this culture of corruption for the region's struggling economies. The technocratic governments of Greek Prime Minister Antonis Samaras and former Italian Prime Minister Mario Monti both made anti-corruption central to their agendas for economic growth, and the PP's recent troubles indicate that Spain may be headed down the same path.

Yet while corruption is undesirable for moral and symbolic reasons (it erodes faith in government, among other things), some academic research suggests that corruption can be good for economies -- or, at least, not as bad as is generally assumed.

According to a 2006 study by Fabio Méndez and Facundo Sepúlveda, there is no linear relationship between corruption and economic growth in regimes rated as "free" by Freedom House. In fact, the economists find that the "growth-maximizing level of corruption [in free countries] is significantly greater than zero, with corruption beneficial for economic growth at low levels of incidence," while also conceding that abnormally high levels of corruption are damaging regardless of government type.

In addition, a 2008 paper by Toke Aidt, Jayasri Dutta, and Vania Sena finds that the quality of institutions in a given country is a major determinant of the effects of corruption. In countries with deficient institutions, corruption has little to no effect on economic growth, because voters cannot punish corrupt politicians. In countries with relatively strong democratic institutions, the researchers conclude that corruption does damage growth, but also that economic growth itself is a strong guarantor of reducing corruption, because it means that "the resource base from which leaders extract rents expands over time."

"This makes them more eager to hold on to political power," they continue, "and creates a benign feedback loop between economic growth and corruption: high growth reduces corruption which, in turn, increases growth."

Neither paper is a ringing endorsement of corruption -- although Méndez and Sepúlveda do note a "growth-maximizing" level of graft - and Aidt, Dutta, and Sena are quick to dispel notions that corruption has a net positive impact on economies. It should also be noted that the academic literature on corruption is mixed at both the theoretical and empirical level, so both should be taken with a grain of salt.

Nevertheless, what these studies suggest is that, by itself, corruption is much less important for a country's economic health than outside factors like the quality of its institutions, the degree of political freedom, and government policy or the state of the national and global economy. As Aidt, Dutta, and Sena put it, "the relationship between corruption and growth is regime specific."

Or, to put it in the context of the current European Union: While anti-corruption measures are probably a net positive in the long run (not to mention an essential PR move in countries rightly seething with anger at their elites), they can also be something of a red herring; in European countries decimated by austerity, teetering banks, and the loss of independent monetary policy, corruption is a secondary issue. And, given the role economic growth plays in reducing corruption, a country looking to clean up its image isn't likely to get there through 9 percent across-the-board spending cuts.