Thanks in part to more widespread availability of information, higher levels of economic integration and the associated greater emphasis on competitiveness and efficiency, and the reduction of ideological barriers, interest in corruption and governance has been surging in recent years (Bardhan 1997, Tanzi 1998), coinciding with greater awareness of the importance of institutions in the process of development (Nugent and Robinson 2002, Acemoglu 2003). As private investment is likely to be a key determinant of growth in most developing countries (Bengoa and Sanchez-Robles 2003), a conjunction of institutional features that have been commonly lumped together under the heading “investment climate” becomes of critical importance In fact, based in most instances on assessments by outside investors or local experts, cross-country indicators to assess various aspects of this phenomenon, compare them, and measure their impact have been developed by academics (Feld and Voigt 2003), independent institutions such Transparency International (Eigen 2002) and the World Bank (Djankov 2002, Batra _et al._ 2003).

Descriptive evidence based on these efforts highlights that a combination of high taxes, arbitrary regulations, policy uncertainty, and low quality of public service delivery and ill-developed financial markets are universally perceived as key constraints to business development. These phenomena are not independent of each other but can in many cases be traced to high levels of corruption that significantly reduce the scope for economic growth and development. This is confirmed by a large number of crosscountry econometric studies that have used indices of different aspects of the phenomenon to demonstrate the harmful impact of corruption on aggregate growth through a variety of mechanisms (Mauro 1995, Bardhan 1997, Tanzi 2000, Mo 2001, Rivera-Batiz 2002, Feld and Voigt 2003). Although more limited, evidence from within country studies supports these results (Gomez and Gallon 2002, Fisman and Gatti 2002b). Two main channels through which such an effect comes about are the type of public services provided and the efficiency of their provision and the level of investment by private entrepreneurs.

A first channel through which corruption affects economic growth is by affecting the composition of public spending and the quality of public service provision. It has long been known that large investment projects provide greater opportunities for government bureaucrats to obtain kick-backs than spending on education and health projects or on operation and maintenance. Indeed, empirical evidence demonstrates that countries with high levels of corruption spend too little on education and health (and on operation and maintenance of past investment) (Mauro 1998), thereby resulting in a significant reduction in the productivity of public investment in countries where, partly due to high cost of raising public revenue, domestic resource mobilization is already insufficient (Ades and Di Tella 1997). This will make it harder for government to fulfill its most important role, to provide public goods (including the enforcement of contracts and protection of property rights), and to impose regulatory controls as a response to market failures. In addition to reducing economic growth, the quality of public service delivery, and foreign investment, this can, in the extreme, lead to a significant reduction in the legitimacy of the state (Tanzi 3