The Role of Monitoring of Corruption in a Simple Endogenous Growth Model

I. INTRODUCTION During the last 30 years, economists from various fields have contributed to the analysis of corruption. The first paper to receive widespread attention was published in 1975 (Rose-Ackerman 1975). Since then a large literature has developed and much attention has been paid to the relationship between corruption and economic growth. In the analysis of the consequences of corruption, the literature supports two opposing positions. On one hand, common wisdom views corruption as an obstacle (sand) to development and growth; on the other hand, other researchers, since the pioneering works of Left (1964) and Huntington (1968), have suggested that corruption may promote efficiency by allowing firms to bypass government failures of various sorts (grease corruption). More recent expositions of efficiency-enhancing corruption can be found in Lui (1985), Acemoglu and Verdier (1998, 2000), and Barreto (2000). Barreto (2000) presents a simple neoclassical endogenous growth model where the public sector's monopolistic position is explicitly considered. Results indicate that a corruption equilibrium is characterized by lower growth rates compared to the ideal situation in which public goods are provided competitively. Barreto (2000) also shows that if the public sector is subject to significant bureaucratic red-tape, all of the agents within the economy may prefer the corruption equilibrium, as corruption can bypass bureaucratic obstacles. From a theoretical point of view, there are several ways in which corruption may reduce economic growth. Corruption can act as a tax and thus lower incentives to invest. Corruption could cause talented people to engage in rent-seeking rather than productive activities. Corruption may distort the composition of government expenditure, as corrupt politicians could be expected to invest in large non-productive projects from which considerable bribes can be extracted more easily than from productive activities. Empirical analysis has also provided evidence of the negative effects of corruption on economic growth. Mauro (1995) shows that corruption reduces economic growth, via reduced private investment. (1) Similar results are obtained by Keefer and Knack (1995) using other measures of corruption and a different selection of countries. (2) Recently, the "grease the wheels" hypothesis has been tested and statistically supported (see Aidt 2009; Campos, Dimova, and Ahmad 2010; Meon and Sekkat 2005, among others). In this article, we develop a theoretical endogenous growth model which incorporates corruption. In our model, the social loss brought about by corruption stems from the fact that firms must bribe a bureaucrat in order to invest, and consequently devote fewer resources to the accumulation of capital. Therefore, in our model, corruption has a negative effect on private investment. Other models share our framework. Ehrlich and Lui (1999) claim that individuals have an incentive to compete over the privilege of becoming bureaucrats (the so-called investment in political capital) since they obtain economic rents through corruption. This investment in political capital consumes economic resources which could otherwise be used for production or investment in human capital. In Del Monte and Papagni (2001), corruption arises when bureaucrats manage public resources to produce public goods and services. Corruption reduces the quality of public infrastructure resulting in a negative effect on economic growth. The novel feature of this article is the study of the impact of monitoring of corruption on economic growth. (3) In our theoretical model, we derive a nonlinear relationship between the level of monitoring and economic growth, as well as between corruption and economic growth. (4) At low monitoring levels, the economy experiences widespread corruption and medium growth rates, whereas no corruption occurs at intermediate monitoring levels, but low growth rates are recorded. …