## _wp02213

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---

### I. Motivation, intuition, and main results
- Observation: corruption and poor governance have substantial, adverse effects on economic growth; countries’ relative degree of corruption is remarkably persistent.
- Key intuition: strategic complementarities can generate multiple equilibria—“good” equilibria with low corruption and high growth, and “bad” equilibria with pervasive corruption and low growth.
- Empirical context cited: indices of corruption (Kaufmann et al., 1999; Keefer and Knack, 1995; Mauro, 1995) suggest substantial economic costs of corruption; policy initiatives include the 1997 OECD Convention on Combating Bribery.
- High-level results:
  - Two complementary formal models are presented that generate multiple equilibria in corruption and growth.
  - Broad policy implications: gradual reforms are less likely to work than ambitious, comprehensive reforms; outside bodies/NGOs may be needed to press for ambitious reforms.
  - Comparative statics indicate countries with low productivity and a large public sector are more likely to end up in the bad equilibrium.

### II. Model I — Multiple equilibria in corruption and economic growth (Section II)
- Framework and assumptions:
  - Infinite-horizon representative-agent setup with isoelastic preferences (σ inverse of intertemporal elasticity of substitution).
  - Individuals allocate one unit of labor between productive work (L) and theft from government (S), with L + S = 1 for each individual.
  - Government expenditure G enters production as in Barro (1990); tax rate τ satisfies τ = (G/Y) and the government runs a balanced budget.
  - φ(S) denotes the proportion of stolen resources that the rent-seeker keeps; φ is a positive function of aggregate S capturing “strength in numbers” (strategic complementarity).
  - Production function (Barro-style) with parameter α; capital accumulation and marginal products determine wage w and rental rate r.
- Mechanism:
  - When aggregate theft S is high, φ(S) is higher → individual marginal product of rent-seeking rises and probability of being caught effectively falls → individuals shift from L to S.
  - Increased rent-seeking lowers labor supply to productive activity and reduces the proportion of G reaching productive processes → lowers marginal product of capital and growth γ.
- Equilibrium structure:
  - Corner (good) equilibrium at L = 1 can exist (no theft).
  - Internal equilibria satisfy a quadratic condition; with a linear φ(S) = a - bS form there can be two internal solutions L1 (unstable) and L2 (stable).
  - Four panel outcomes (Figure 1): only L=1; multiple equilibria with L2 < L1 < 1; only corner L=1 despite two real roots; only internal stable L2 when L2 < 1 < L1.
- Comparative statics (qualitative and parameter-dependent):
  - Increases in τ (tax rate / share of public expenditure) make real internal solutions more likely; raise L1 (increase probability of ending up in bad equilibrium); worsen welfare in the bad equilibrium.
  - Decreases in α (productivity parameter) make internal solutions more likely and raise the likelihood of the bad equilibrium but may improve welfare in the bad equilibrium.
  - Increases in θ (parameter scaling φ(S)) make internal solutions more likely, raise L1, and worsen welfare in the bad equilibrium.
  - Parameters a, b in φ(S) affect existence and properties of equilibria; effects of b are ambiguous and depend on other parameters.
- Welfare:
  - Welfare is monotonic in the growth rate; higher L unambiguously implies higher welfare.
- Qualitative conclusions from Model I:
  - Large public sector and higher tax-financed government expenditure (higher τ) can be deleterious for corruption and economic performance, other things equal.
  - Improvements in the state’s ability to protect public expenditure (reductions in θ) help curb rent-seeking.

### III. Model II — Multiple equilibria in corruption, political stability, and growth (Section III)
- Framework and assumptions:
  - Two-period model with government composed of N politicians indexed i = 1,...,N.
  - Each politician sets up a bribe collection system and chooses a bribe rate τi in period 1; total bribe rate τ = Σi τi.
  - Citizens observe aggregate τ (and aggregate variables) but cannot observe individual τi as long as τi < τM; τM is an upper bound (if τi ≥ τM politician is identified and punished).
  - Citizens decide at end of period 1 whether to reelect the government or oust it; ousting entails an efficiency loss λ (multiplicative) and temporary production disruption.
  - Citizens and politicians have isoelastic utility (σ) and no discounting in baseline.
  - Production: linear technology y = a s for saved s.
- Citizens’ condition to oust:
  - Citizens oust the government iff λ < τ.
- Politicians’ payoffs:
  - If government not ousted, politician i receives utility as a function of τi and remaining aggregate τ; if ousted, politician i receives a lower payoff (limited second-period endowment ep).
- Cooperative solution:
  - Politicians could coordinate to set τi = λ/N ∀i to maximize reelection-compatible bribe extraction; alternatively choose τi = τM if cooperation yields lower utility than defecting to τM.
- Non-cooperative equilibria:
  - Bad equilibrium: all politicians levy τM. If others levy τM, any politician optimally sets τM because collapse is inevitable.
  - Good equilibrium: all politicians levy λ/N is a Nash equilibrium only if the utility from cooperation (*) exceeds the utility from levying τM (**); existence of good equilibrium depends on parameter comparisons.
- Comparative statics and implications:
  - Lower τM (easier to catch corrupt politicians / greater transparency) raises the likelihood that a good equilibrium exists and improves welfare in the bad equilibrium.
  - Decreasing N (fewer politicians/elite members) raises the likelihood of the good equilibrium and lowers total bribe rate in the bad equilibrium.
  - Increasing λ (higher efficiency loss from ousting) can increase the chance of a good equilibrium under conditions (e.g., λ < 0.5 and σ > 1), but increases in λ lower citizens’ welfare in both equilibria.
  - Higher a (technological efficiency) makes cooperative outcome more likely—consistent with empirical evidence that corruption tends to be higher in poorer countries.
- Qualitative conclusions from Model II:
  - Strategic complementarity arises because one politician’s corruption shortens others’ horizons (reduces reelection probability), inducing others to extract more today.
  - Corruption, political instability (government ousting), and low investment/growth can be mutually reinforcing.

### IV. Policy implications and concluding remarks (Section IV)
- Summary of theoretical insights:
  - Both models rely on strategic complementarities to explain persistent, self-perpetuating high-corruption, low-growth equilibria.
  - The models provide theoretical support for observed correlations: corruption ↔ political instability ↔ low investment and slow growth.
- Policy-relevant comparative findings:
  - Countries with low productivity (low α) and large public sectors (high τ) are more likely to be trapped in the bad equilibrium.
  - Policies that reduce τM (increase transparency and the ability to detect individual politicians’ corruption) make good equilibria more likely and improve welfare even in bad equilibria.
  - Reducing the size of the elite (N) or improving state capacity to protect public expenditure (reducing θ) can help avoid bad equilibria.
- General policy recommendations derived from the models:
  - Gradual, piecemeal reforms are less likely to succeed than ambitious, comprehensive reforms when strategic complementarities generate multiple equilibria.
  - External pressure or assistance (from outside bodies or NGOs) may be necessary to induce the switch from bad to good equilibria in some countries.
  - Policies aimed at improving transparency and information dissemination that enable citizens to identify corrupt officials are helpful in curbing corruption and enabling higher growth.

*Source: _wp02213 - References*

### References  ............................................................................................................

### _wp02213 - References

### I. Motivation, intuition, and main results
- Observation: corruption and poor governance have substantial, adverse effects on economic growth; countries’ relative degree of corruption is remarkably persistent.
- Key intuition: strategic complementarities can generate multiple equilibria—“good” equilibria with low corruption and high growth, and “bad” equilibria with pervasive corruption and low growth.
- Empirical context cited: indices of corruption (Kaufmann et al., 1999; Keefer and Knack, 1995; Mauro, 1995) suggest substantial economic costs of corruption; policy initiatives include the 1997 OECD Convention on Combating Bribery.
- High-level results:
  - Two complementary formal models are presented that generate multiple equilibria in corruption and growth.
  - Broad policy implications: gradual reforms are less likely to work than ambitious, comprehensive reforms; outside bodies/NGOs may be needed to press for ambitious reforms.
  - Comparative statics indicate countries with low productivity and a large public sector are more likely to end up in the bad equilibrium.

### II. Model I — Multiple equilibria in corruption and economic growth (Section II)
- Framework and assumptions:
  - Infinite-horizon representative-agent setup with isoelastic preferences (σ inverse of intertemporal elasticity of substitution).
  - Individuals allocate one unit of labor between productive work (L) and theft from government (S), with L + S = 1 for each individual.
  - Government expenditure G enters production as in Barro (1990); tax rate τ satisfies τ = (G/Y) and the government runs a balanced budget.
  - φ(S) denotes the proportion of stolen resources that the rent-seeker keeps; φ is a positive function of aggregate S capturing “strength in numbers” (strategic complementarity).
  - Production function (Barro-style) with parameter α; capital accumulation and marginal products determine wage w and rental rate r.
- Mechanism:
  - When aggregate theft S is high, φ(S) is higher → individual marginal product of rent-seeking rises and probability of being caught effectively falls → individuals shift from L to S.
  - Increased rent-seeking lowers labor supply to productive activity and reduces the proportion of G reaching productive processes → lowers marginal product of capital and growth γ.
- Equilibrium structure:
  - Corner (good) equilibrium at L = 1 can exist (no theft).
  - Internal equilibria satisfy a quadratic condition; with a linear φ(S) = a - bS form there can be two internal solutions L1 (unstable) and L2 (stable).
  - Four panel outcomes (Figure 1): only L=1; multiple equilibria with L2 < L1 < 1; only corner L=1 despite two real roots; only internal stable L2 when  L2 < 1 < L1.
- Comparative statics (qualitative and parameter-dependent):
  - Increases in τ (tax rate / share of public expenditure) make real internal solutions more likely; raise L1 (increase probability of ending up in bad equilibrium); worsen welfare in the bad equilibrium.
  - Decreases in α (productivity parameter) make internal solutions more likely and raise the likelihood of the bad equilibrium but may improve welfare in the bad equilibrium.
  - Increases in θ (parameter scaling φ(S)) make internal solutions more likely, raise L1, and worsen welfare in the bad equilibrium.
  - Parameters a, b in φ(S) affect existence and properties of equilibria; effects of b are ambiguous and depend on other parameters.
- Welfare:
  - Welfare is monotonic in the growth rate; higher L unambiguously implies higher welfare.
- Qualitative conclusions from Model I:
  - Large public sector and higher tax-financed government expenditure (higher τ) can be deleterious for corruption and economic performance, other things equal.
  - Improvements in the state’s ability to protect public expenditure (reductions in θ) help curb rent-seeking.

### III. Model II — Multiple equilibria in corruption, political stability, and growth (Section III)
- Framework and assumptions:
  - Two-period model with government composed of N politicians indexed i = 1,...,N.
  - Each politician sets up a bribe collection system and chooses a bribe rate τi in period 1; total bribe rate τ = Σi τi.
  - Citizens observe aggregate τ (and aggregate variables) but cannot observe individual τi as long as τi < τM; τM is an upper bound (if τi ≥ τM politician is identified and punished).
  - Citizens decide at end of period 1 whether to reelect the government or oust it; ousting entails an efficiency loss λ (multiplicative) and temporary production disruption.
  - Citizens and politicians have isoelastic utility (σ) and no discounting in baseline.
  - Production: linear technology y = a s for saved s.
- Citizens’ condition to oust:
  - Citizens oust the government iff λ < τ.
- Politicians’ payoffs:
  - If government not ousted, politician i receives utility as a function of τi and remaining aggregate τ; if ousted, politician i receives a lower payoff (limited second-period endowment ep).
- Cooperative solution:
  - Politicians could coordinate to set τi = λ/N ∀i to maximize reelection-compatible bribe extraction; alternatively choose τi = τM if cooperation yields lower utility than defecting to τM.
- Non-cooperative equilibria:
  - Bad equilibrium: all politicians levy τM. If others levy τM, any politician optimally sets τM because collapse is inevitable.
  - Good equilibrium: all politicians levy λ/N is a Nash equilibrium only if the utility from cooperation (*) exceeds the utility from levying τM (**); existence of good equilibrium depends on parameter comparisons.
- Comparative statics and implications:
  - Lower τM (easier to catch corrupt politicians / greater transparency) raises the likelihood that a good equilibrium exists and improves welfare in the bad equilibrium.
  - Decreasing N (fewer politicians/elite members) raises the likelihood of the good equilibrium and lowers total bribe rate in the bad equilibrium.
  - Increasing λ (higher efficiency loss from ousting) can increase the chance of a good equilibrium under conditions (e.g., λ < 0.5 and σ > 1), but increases in λ lower citizens’ welfare in both equilibria.
  - Higher a (technological efficiency) makes cooperative outcome more likely—consistent with empirical evidence that corruption tends to be higher in poorer countries.
- Qualitative conclusions from Model II:
  - Strategic complementarity arises because one politician’s corruption shortens others’ horizons (reduces reelection probability), inducing others to extract more today.
  - Corruption, political instability (government ousting), and low investment/growth can be mutually reinforcing.

### IV. Policy implications and concluding remarks (Section IV)
- Summary of theoretical insights:
  - Both models rely on strategic complementarities to explain persistent, self-perpetuating high-corruption, low-growth equilibria.
  - The models provide theoretical support for observed correlations: corruption ↔ political instability ↔ low investment and slow growth.
- Policy-relevant comparative findings:
  - Countries with low productivity (low α) and large public sectors (high τ) are more likely to be trapped in the bad equilibrium.
  - Policies that reduce τM (increase transparency and the ability to detect individual politicians’ corruption) make good equilibria more likely and improve welfare even in bad equilibria.
  - Reducing the size of the elite (N) or improving state capacity to protect public expenditure (reducing θ) can help avoid bad equilibria.
- General policy recommendations derived from the models:
  - Gradual, piecemeal reforms are less likely to succeed than ambitious, comprehensive reforms when strategic complementarities generate multiple equilibria.
  - External pressure or assistance (from outside bodies or NGOs) may be necessary to induce the switch from bad to good equilibria in some countries.
  - Policies aimed at improving transparency and information dissemination that enable citizens to identify corrupt officials are helpful in curbing corruption and enabling higher growth.

*Source: _wp02213 - References*

### REFERENCES

### REFERENCES

### Books and Monographs
- Abbott, Elizabeth, 1988, Haiti: The Duvaliers and Their Legacy (New York: McGraw-Hill).
- De Soto, Hernando, 1989, The Other Path (New York: Harper and Row).
- Hibbs, Douglas A., 1973, Mass Political Violence: A Cross-National Causal Analysis (New York: John Wiley).
- North, Douglass C., 1990, Institutions, Institutional Change and Economic Performance, (Cambridge, England; New York: Cambridge University Press).
- Putnam, Robert D., 1993, Making Democracy Work: Civic Traditions in Modern Italy, (Princeton, New Jersey: Princeton University Press).

### Journal Articles (selected)
- Andvig, Jens C., and Karl Ove Moene, 1990, “How Corruption May Corrupt,” Journal of Economic Behavior and Organization, Vol. 13, pp. 63–76.
- Bardhan, Pranab, 1997, “Corruption and Development: A Review of Issues,” Journal of Economic Literature, Vol. 35, No. 3, pp. 1320–46.
- Barro, Robert J., 1990, “Government Spending in a Simple Model of Endogenous Growth,” Journal of Political Economy, Vol. 98, No. 5, part 2, pp. S103–S125.
- Cadot, Olivier, 1987, “Corruption as a Gamble,” Journal of Public Economics, Vol. 33, No. 2, pp. 223–44.
- Cooper, Russell, and Andrew John, 1988, “Coordinating Coordination Failures in Keynesian Models,” Quarterly Journal of Economics, Vol. 53, No. 3, pp. 441–63.
- Dawid, Herbert, and Gustav Feichtinger, 1996, “On the Persistence of Corruption,” Journal of Economics, Vol. 64, No. 2, pp. 177–93.
- Huang, Peter H., and Ho-Mou Wu, 1994, “More Order Without More Law: A Theory of Social Norms and Organizational Cultures,” Journal of Law, Economics, and Organization, Vol. 10, No. 2, pp. 390–406.
- Kaufmann, Daniel, Aart Kraay, and Pablo Zoido-Lobatón, 1999, “Governance Matters,” World Bank Policy Research Working Paper No. 2196 (Washington: World Bank).
- Knack, Stephen, and Philip Keefer, 1995, “Institutions and Economic Performance: Cross-Country Tests Using Alternative Institutional Measures,” Economics and Politics, Vol. 7, No. 3, pp. 207–27.
- Krueger, Anne O., 1993, “Virtuous and Vicious Circles in Economic Development,” American Economic Review, Papers and Proceedings, Vol. 83, No. 2, pp. 351–56.
- Krueger, Anne O., 1974, “The Political Economy of the Rent-Seeking Society,” American Economic Review, Vol. 64, No. 3, pp. 291–303.
- Mauro, Paolo, 1995, “Corruption and Growth,” Quarterly Journal of Economics, Vol. 110, No. 3, pp. 681–712.
- Murphy, Kevin M., Andrei Shleifer, and Robert W. Vishny, 1991, “The Allocation of Talent: Implications for Growth,” Quarterly Journal of Economics, Vol. 106, pp. 503–30.
- Murphy, Kevin M., Andrei Shleifer, and Robert W. Vishny, 1993, “Why Is Rent-Seeking So Costly to Growth?” American Economic Review, Papers and Proceedings, Vol. 83, No. 2, pp. 409–14.
- Sah, Raaj K., 1991, “Social Osmosis and Patterns of Crime,” Journal of Political Economy, Vol. 99, No. 6, pp. 1272–95.
- Shleifer, Andrei, and Robert Vishny, 1993, “Corruption,” Quarterly Journal of Economics, pp. 599–617.
- Tanzi, Vito, 1998, “Corruption Around the World,” Staff Papers, International Monetary Fund, Vol. 45, No. 4, pp. 559–94.
- Tirole, Jean, 1996, “A Theory of Collective Reputations (with Applications to the Persistence of Corruption and to Firm Quality),” Review of Economic Studies, Vol. 63, No. 1, pp. 1–22.
- Wade, Robert, 1982, “The System of Administrative and Political Corruption: Canal Irrigation in South India,” Journal of Development Studies, Vol. 18 (April), pp. 287–328.
- Cooper, Russell, and Andrew John, 1988, “Coordinating Coordination Failures in Keynesian Models,” Quarterly Journal of Economics, Vol. 53, No. 3, pp. 441–63.

### IMF and Policy-Oriented Documents
- International Monetary Fund, “The IMF's Approach to Promoting Good Governance and Combating Corruption—A Guide,” http://www.imf.org/external/np/gov/guide/eng/index.htm
- Kaufmann, Daniel, Aart Kraay, and Pablo Zoido-Lobatón, 1999, “Governance Matters,” World Bank Policy Research Working Paper No. 2196 (Washington: World Bank).
- Tanzi, Vito, 1998, “Corruption Around the World,” Staff Papers, International Monetary Fund, Vol. 45, No. 4, pp. 559–94.

*Content derived from: _wp02213 - REFERENCES*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2002/_wp02213.pdf_