The Effect of Income The Effect of Income on Corruptionon Corruption

Brittni SmithBrittni SmithDepartment of Economics and ManagementDepartment of Economics and Management

Hood CollegeHood CollegeApril 16, 2010April 16, 2010

CorruptionCorruption

Misuse of public power for personal or Misuse of public power for personal or private gainprivate gain

ExamplesExamples Former Governor of Illinois Rod Blagojevich: Former Governor of Illinois Rod Blagojevich:

auctioning off President Obama’s Senate seat auctioning off President Obama’s Senate seat In 2009, China has convicted 106,000 officials for In 2009, China has convicted 106,000 officials for

corruptioncorruption Senior official accused of taking $500,000 dollars in Senior official accused of taking $500,000 dollars in

bribes from businesses seeking approval of projects. bribes from businesses seeking approval of projects. Former vice president of China’s highest court was jailed Former vice president of China’s highest court was jailed

for life for bribes totaling $600,000for life for bribes totaling $600,000

CorruptionCorruption

Seminal Work by Mauro (1995) Seminal Work by Mauro (1995) Consequence of corruption is lower investment which Consequence of corruption is lower investment which

decreases developmentdecreases development

President of the World Bank Jim Wolfensohn, President of the World Bank Jim Wolfensohn, ““Let’s not mince words, we need to deal with the Let’s not mince words, we need to deal with the

causes of corruption.” (1996) causes of corruption.” (1996)

Today considered to be one of the biggest Today considered to be one of the biggest obstacles to economic development.obstacles to economic development.

Countries in Corruption IndexCountries in Corruption Index

New Zealand

0.6

Somalia

8.9

LeastCorrupt

Most Corrupt

Spain

2.5

USAChina

MexicoRussia

HaitiAfghanistan

7.86.76.4 8.2 8.7

S. Korea

4.54

Corruption IndexCorruption Index

Source: Transparency InternationalSource: Transparency International World Bank World Bank

Perceived level of corruption in a country Perceived level of corruption in a country Based on poll-of-polls data from:Based on poll-of-polls data from:

Experts and business persons in the country and Experts and business persons in the country and abroad abroad

Independent, reputable institutions Independent, reputable institutions Ex) World BankEx) World Bank

Available from 1995-present for 178 countries. Available from 1995-present for 178 countries. Panel data: for each country there are 14 Panel data: for each country there are 14

observations, total of 2,492 observations.observations, total of 2,492 observations.

Frechette (2006)Braun-Di Tella (2004)

Treisman (2000)

Brown (2005), Kunicova-R. Ackerman (2005), Lederman (2005), Chang-Golden (2004),

Damania (2004), Dreher (2004),

Alt-Lassen (2003), Brunett-Weder (2003),

Graeff-Mehlkop (2003), Herzfeld-Weiss (2003), Knack-Azfar (2003) Person (2003),

Tavares (2003), Fisman-Gatti (2002),

Paldam (2001), Bonanglia(2001),

Swamy (2001), Abed-Davoodi (2000),

Rauch-Evan (2000), Wei (2000),

Goldsmith (1999), Ades-Di Tella (1997)

Income

Positive-SignificantNegative-SignificantVariable

Previous Studies on the Previous Studies on the Effect of Income on CorruptionEffect of Income on Corruption

Fixed-EffectsFixed-Effects Focus: Focus: time-varyingtime-varying factors of corruption factors of corruption

Ex) Income, education, etc.Ex) Income, education, etc.

Error term of model accounts for: Error term of model accounts for: Time-invariant factors that could effect corruptionTime-invariant factors that could effect corruption

Ex) Colonization, religion, geography and could affect Ex) Colonization, religion, geography and could affect corruptioncorruption

Country unobservablesCountry unobservables Could be correlated and potentially fostering corruption Could be correlated and potentially fostering corruption Accounting for the unaccountableAccounting for the unaccountable

EndogeneityEndogeneity

ititoit CorruptionIncome εββ +++= ...)(1

Income is endogenous with corruption Causal relationship

ititoit IncomeCorruption εββ +++= ...)(1

Direction of causation is not clear Do low income countries generate more

corruption? Does corruption makes countries poorer?

Frechette (2006)Frechette (2006)

ICRG index ICRG index Fixed-effects specification Fixed-effects specification Accounts for this endogenous relationship Accounts for this endogenous relationship Main findings: Main findings:

Income increases corruptionIncome increases corruption Education increases corruption Education increases corruption

Explanatory VariablesExplanatory Variables

(-)(-) IncomeIncome Real GDP per capitaReal GDP per capita

(-)(-) EducationEducation Number of pupils in primary schoolNumber of pupils in primary school

(-)(-) Share of Imports in GDPShare of Imports in GDP Merchandise trades as % of GDPMerchandise trades as % of GDP

(+)(+) Fuel, Ore, and Mineral Exports Fuel, Ore, and Mineral Exports % of Merchandise exports% of Merchandise exports

(-)(-) InternetInternet Number of UsersNumber of Users

Instrument VariableInstrument Variable

Instrument should be correlated with income but Instrument should be correlated with income but should not directly effect corruptionshould not directly effect corruption

Income

OECD Trading

Partner's Income

Haiti

U.S.

Corruption

Isolate endogenous variable

Instrument to be statistically significant

F statistic >10

First Stage Regression

Non-Linear Relationship Non-Linear Relationship Between Corruption and IncomeBetween Corruption and Income

02

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0 20 40 60 80Income

Corruption Fitted values

The Effect of Income on Corruption

Bangladesh

Luxembourg

02

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ptio

n

0 20 40 60 80Income

Corruption Fitted values

The Effect of Income on Corruption

ModelModel Specifies non-linear relationship between

income and corruption

Two-Stage Least Squares with: Panel Data Fixed-Effects Instrument Variable

Sub-Sample Income LevelsSub-Sample Income Levels

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Corruption Fitted values

The Effect of Income on Corruption

Various Income Levels

***, **, * indicate statistical significance at the 1%, 5%, and 10% level respectively

Standard errors in parenthesis

ConclusionsConclusions

Non-linear relationship between income Non-linear relationship between income and corruptionand corruption

Subsample reveals as income increases, Subsample reveals as income increases, corruption decreases at a decreasing ratecorruption decreases at a decreasing rate

Internet reduces corruption for countries Internet reduces corruption for countries with income above $18,000.with income above $18,000.

SummarySummary

Clearly shows as income increases corruption Clearly shows as income increases corruption decreasesdecreases Opposite of Frechette (2006).Opposite of Frechette (2006).

Same technique as Frechette panel data and Same technique as Frechette panel data and fixed-effects methodfixed-effects method

Corrected for problems in past empirical Corrected for problems in past empirical research research

Endogeneity of income Endogeneity of income Non-linear relationship between income and corruptionNon-linear relationship between income and corruption

Proved using this model the results is income Proved using this model the results is income does decrease corruption but differently with does decrease corruption but differently with countries of different income levels. countries of different income levels.