Corruption is a significant barrier to growth and development, raising both the costs and the risks of business activity and deterring investment. This column explores the opposite causal relationship: the effect of growth on corruption. Both theoretical and empirical evidence show that economic growth can cause corruption to fall. What’s more, policies that support the growth and mobility of businesses hold the promise of sparking a ‘race to the top’ in the eradication of corruption.
Eradicating corruption ranks among the central policy concerns of development practitioners around the globe. In his 1996 ‘cancer of corruption’ speech, the then president of the World Bank James Wolfensohn spelled out a theoretical mechanism connecting corruption and poverty:
‘Corruption diverts resources from the poor to the rich, increases the cost of running businesses, distorts public expenditures and deters foreign investors… it is a major barrier to sound and equitable development’.
Indeed, regardless of whether analysts use data on perceptions of corruption collected by Transparency International and the World Bank, or individual bribe payments reported in household and enterprise surveys, there is a strong negative correlation between a country’s per capita income and the level of reported corruption.
The traditional explanation for this relationship has been the theory articulated by Wolfensohn: corruption increases the cost and risk of business activity, thereby deterring investment and depressing growth that could have lifted citizens out of poverty.
But there is an alternative possibility that has received less attention among development researchers and practitioners. The strong relationship between income and growth may result from exactly the opposite causal relationship: countries may be growing out of corruption. Over time, economic growth reduces both the incentives for government officials to extract bribes and firms’ willingness to pay them.
Some scholars from developed countries have discussed this possibility in terms of a ‘life cycle’ theory with corruption peaking at early stages of development and declining as countries industrialise. But there has been little work either testing for this empirical link from growth to corruption, or laying out the specific mechanisms that could generate the link.
In a recent study with my co-authors Jie Bai, Edmund Malesky and Benjamin Olken, we do just that. Analysing survey data collected over a five-year period from more than 10,000 firms in Vietnam, we provide evidence that the growth of firms leads to a fall in the amount of corruption – specifically the ‘bribe rate’ or the share of firms’ revenues that are skimmed off by officials in bribes. We also explain why the impact of firms getting bigger and more profitable reduces the bribe rate.
Economists have long observed that corruption more acutely afflicts markets in developing countries, where firms are smaller, than in richer countries. Even within countries, smaller firms pay a higher bribe rate on average. But because lower bribe rates are also likely to enable firms to grow faster, previous research has largely been unable to disentangle cause and effect.
Our data enable us to estimate how province-level bribe rates respond to the local growth rate – and what we find is that a doubling of employment in an industry leads to a 35% reduction in the bribe rate within that industry. The reason is that firms in these industries are more attractive and important for a local government to retain. Officials fear that if they ask for too much, the superstar businesses will relocate, so there is a reduction in the ‘ask’ of these firms.
These findings provide an endorsement of Vietnam’s move in the 1990s to decentralise business-government interactions to the provincial level and to encourage provinces to compete to provide the best environment for business.
Indeed, the data source we use is named the ‘Provincial Competitiveness Index’ survey, as one of its other uses is to create a league table that ranks provinces by their attractiveness for business. When firms have access to and make decisions based on this information, provincial governments have an incentive to clean up their act and climb up the league table.
The dynamic explained above requires that businesses have a credible threat to relocate if government officials demand too much in bribes. We present a series of fine-grained analyses that show that this is indeed the case.
First, we find that firm growth reduces the bribe rate more strongly among firms that hold land certificates than among those that do not. Having a land certificate lowers the cost of moving since the company has the right to sell the land from which it is moving away; without a certificate, it would forfeit the value of the land.
Second, growth reduces bribe rates more among firms that operate in multiple provinces. This is probably because it is cheaper to scale back operations in one province and increase operations in another than it would be for a firm to establish an entirely new provincial branch.
Taken together, this evidence lends powerful credence to the proposition that policies that support the growth and mobility of businesses hold the promise of sparking a ‘race to the top’ in the eradication of corruption. While our study focuses on Vietnam and each country’s business environment is unique, the findings may apply to other countries in which sub-national governments play a key role in interfacing with businesses, such as China.