Infinite grim punishments are too severe for large discount factors. There is extensive public provision of private goods in all developed countries. Disregarding administrative costs, a system where individuals are not allowed to top up is optimal if the demand for the publicly provided good increases in the amount of leisure available, while a scheme allowing individuals to top up is warranted if the demand decreases with the amount of leisure. Corruption opportunities arise when a principal delegates enforcement or audit authority to a supervisor. The supervisor may then strike a deal with the agent she is supposed to monitor and conceal important information from the principal.
Corruption imposes a constraint on governance and appears therefore to be harmful for the principal.
We show that this need not be the case. In our model, the prospect of corruption can make the principal better off. The reason is that the collusion possibility generates dynamic effects which, in cases where only limited intertemporal commitments can be made, may be beneficial for the principal. I show that this feature allows the domestic investment rate to be closely associated with the domestic saving rate even when international financial markets are integrated. I also argue that this feature is important in explaining the observed cross-country diversity in growth performance and saving behavior.