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Simultaneous Equations Model

PROPOSAL: Growth and Corruption

Determining the relationship between growth and corruption
!In partial fulllment of the requirement for ECOMET2 !Presented to Cesar Runo of the Economics Department !De La Salle University - Manila !By Abbey Media John Sarao Bon Tiangson Stephanie Zeng

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A number of developing countries in Asia has been having few great years. The Philippines in particular has had increasing growth rate in 2012 and first two quarters of 2013 with the following GDP numbers respectively: 6.8%, 7.6%, (2013 numbers are the average of the first two quarters)1. It is a fact that corruption is much higher in developing countries [Bai & Jayachandran, 2013] and with the recent positive economic outbursts in the said countries2 the debate on how corruption affects economic growth has drawn many economists and policy makers interest. Again, taking Philippines as an example, in 2012 despite a high GDP number (6.8%) and the current Aquino administrations efforts to eradicate corruption, the country was still perceived to one of the most corrupt country in the world getting a score of 34 on a scale of 1 to 100 with 100 being very clean 3, which makes the effects of corruption on growth unclear.

The goal is to have sustained economic growth 4 and in order to achieve

it, policymakers must find the best policy mix for a country. Finding out the relationship of corruption and growth empirically could provide a better (and possibly a more accurate) policy.

1 2

Numbers obtained from the World Bank.

According to data out of the IMF, for the first time in history the combined GDP of emerging market economies has risen above that of developed nations (i.e Philippines, Indonesia and Malaysia). Adjusting for price parity, gross domestic product for those emerging markets will total $44.4 trillion in 2013, while advanced economies will produce $42.8 trillion.

From Corruption Perceptions Index of Transparency International. Real output increases over a sustained period of time.

Using the 1979 to 2001 cross-sectional dataset, the authors of this paper primarily aim to: (1) identify the channels through which corruption and other institutional factors affect economic growth, and (2) to quantify the weight of these effects.

! ! Corruption is a result of weak state management and exists when

individuals or organizations have monopoly power over a good or service, discretion over making decisions, limited or no accountability, and low level of income [Rehman & Naveed, et al.]. From the point of view of a developing country, the corruption in the public sector is more vital because it is where corruption activities are more evident unlike in the private sector; corruption is more done in a discreet manner. Most economists have continually supported the notion that corruption hinders an economy from experiencing growth while there are still some others who think otherwise; that is, they believe that corruption might actually induce economic growth [Mauro, 1995]. Some studies claimed that corruption promotes enterprise, commerce and investment, while others have maintained that corruption definitely slow down the promotion by institutional efficiency through its continual persistence [Rehman & Naveed, et al.]. In this sense, a sustained economic growth requires good governance and equity system under control [Tanner and Liu, 1994]. The question now is whether good governance and/or equity system are suitable predictors for economic growth. Government officials may use their

authority for private gain through designing and implementing public policies. Some economists suggests that corruption can possibly raise economic growth in countries where bureaucratic ruling is inefficient due to procedures such as speed money, which is said to avoid bureaucratic delays and bribery which is assumed to increase government employees productivity. A study by Mallik and Sahab [2010] using panel generalized method of moments found that when bureaucratic regulations are reduced corruption increases growth. Whereas, some studies suggest that corruption decreases economic growth. Mauros [1995] cross-country, perceptive-measure study of the relationship between corruption and growth, found that corruption to decreases investment hence decreasing economic growth. Another point of view about corruption is that it reduces growth. Myrdal [1968] advocated that rather than speeding up the process, corrupt officials actually caused severe administrative delays in order to attract more bribes. When corruption is pervasive, the person paying the bribe is often forced to engage in more malpractice by bribing others and those in higher authority, which further increases transaction costs. Given these reasons, corruption delegitimizes the working of a market economy, as well as the outcomes of political processes within the government [Tanzi, 2006].

For the different governance indicators, we use the World Governance Indicators provided by the World Bank and Revenue Watch and Brookings Institution. These indicators are aggregated from 31 unique data sources that reflect the views of various think tanks, survey institutes, non-government institutions, private firms, and international organizations.

The data for GDP growth and the different control variables used are obtained from the World Data Bank.


We treat GDP growth (%changeinGDP) as the dependent variable and set control of corruption (Corrupt), government effectiveness (Eff), and voice and accountability (Voice) as independent variables.

The aforementioned variables do not in themselves determine GDP growth, and as such, we need to control for the other determinants of growth to avoid omitted variable bias. We use the same control variables employed by Mauro in his 1995 study. These include primary education (Pe), secondary education (Se), and government spending (G). Because growth and corruption may have a two-way relationship (i.e. growth affects governance and governance affects growth), the problem of endogeneity bias arises. We thus use the 2 square least square model (2SLS) to estimate, a type of simultaneous equation model, as an estimation procedure, and ethnolinguistic fractionalization as an instrument, which has been found to be highly correlated with corruption and other governance indicators.

Bai, J., Jayachandran, S., Malesky, E., & Olken, B. (2013). Does economic growth reduce corruption? Theory and evidence from Vietnam. National Bureau of Economic Research, Working Paper No. 19483. Retrieved November 4, 2013, from http://www.nber.org/papers/w19483.pdf?new_window=1 Mallika, G., & Sahabb, S. (n.d.). Growth and Corruption: A Complex Relationship. Retrieved Nov 4, 2013, from http://www.isid.ac.in/~pu/ conference/dec_12_conf/Papers/GirijashankarMallik.pdf Mauro, P. (1997). Why Worry About Corruption? Economic Issue. 6 (2). International Monetary Fund. Mauro, P. (1995). Corruption and Growth. Quarterly Journal of Economics. 110. pp: 681-712. Myrdal, G. 1968. Asian Drama. Penguin. Harmonodsworth. 2. Robinson 1971 Rehman, H.U. & Naveed, A. Determinants of Corruption and its Relation to GDP: (A Panel study). Journal of Political Studies. pp27-59. Tanner, E. and P. Liu. 1994. Is the budget deficit too large?: some further Evidence. Economic Inquiry. 32, pp: 511-518. Tanzi, V. 1995. Corruption, Arms Length Relationships, and Markets. The Economics of Organized Crimes, edited by Gianluca Fiorentini and Sam Peltzman, Cambridge: Cambridge University Press, pp:161-180. World Bank, 1997. World Development Report: The State in a Changing World. Oxford University Press. New York. The Worldwide Bank Group (2013). Worldwide Governance Indicators. Retrieved from http://info.worldbank.org/governance/wgi/index.aspx#home