Corrupting the Youth: Should developing nations prioritize

minimizing corruption in order to achieve economic growth?

A Cross-Section Analysis
Ben Ophoven-Baldwin
Introduction
Research regarding corruption and growth making its way to the spotlight of economic
research. Ever since the huge institutions such as the International Monetary Fund and The
World Bank cited corruption as a major hurdle towards economic development, this topic has
seen a huge surge. Despite many of the worlds great minds putting their time and energy into
this topic, there has been little consensus about the true nature of corruption and economic
growth.
There exists a significant amount of corruption research but this is still a pretty new topic
researched in economics. In fact, this topic has been much more prevalent in law, sociology, and
political science. These fields make it much easier to explain the subjective nature of corruption
without the need for quantifiable figures. However, in the 1960s, economists joined the
conversation about the relationship between corruption and economic growth.
Economists argue both sides of the corruption/growth relationship. Many researchers say
corruption hinders economic development but interestingly enough, there are many that say
corruption is actually beneficial and works as grease money which can serve as replacement
for missing institutions (credit, financing, etc). (Kaufmann 1999)
In addition to producing conflicting results, corruption has proven to be controversial in
regards to the way it is measured. Getting back to the earlier point about corruption being widely
seen as a social issue, its been a very hard concept to measure. Many measures are based on
perception and opinions. Surveys are combined with legal corruption data and historical records
to create some sort of picture about the status of corruption in a country. Combining such
subjective data with concrete figures such as GDP and population growth can lead to less than
perfect results.
Governments are allocating significant amounts of time and money towards stopping
corruption. Many economies developed with little corruption controls but now it seems
developing nations are being pushed to curb corruption. Is this an effective use of capital for a
developing nation? This is the problem I would like to address.
The hypotheses to be tested are:
H0: bcorr=0
H1: 0 < bcorr< 0
Given the characteristics of corruption and growth studies, this subject needs to be
approached with caution. The decision of what to include in a regression model will prove itself

to be a very slow and deliberate task in order to not violate any regression assumptions. Only
through a thorough analysis of past research and publications will I be able to observe a
dependable relationship between growth and corruption.

Literature review
In order to create a reliable model about corruption and economic performance, it is
paramount to examine the diverse research from the past regarding this relationship. The
historical research has lead to two distinct views: The first view is that corruption hinders
economic efficiency and performance. The idea is that corruption will hinder public institutions,
decrease education expenditure, and create inequality in resource allocation (Egunjobi 2013).
The first majorly accepted work that supported this view was Mauros Corruption and
Growth. This analysis came to the conclusion that 1 standard deviation decrease in the
corruption index would lead to an increase in annual growth rates of GDP per capita by 0.8
percent (Mauro 1995). Mauros study was limited by the amount of evidence available pertaining
to development indicators on the international level. Due to this lack of data, Mauro used data
from only 16 nations over the time span 1960-1980. Mauros analysis did show a concrete
relationship about the effects of corruption but the span of the data leaves something to be
desired.
An interesting companion to Mauros work lies with a publication by Nobuo Akai,
Yusaku Horiuchi and Masayo Sakata called Short-run and Long-run Effects of Corruption on,
Economic Growth: Evidence from State-Level, Cross-Section Data for the United States
(2005). This study aims to circumvent the lack of complete data on the international level.
Instead of focusing on the entire world. Akai, Horiuchi and Sakata focus on the United States as
a microcosm to analyze the effect of corruption on governmental efficiency and economic
growth over different time spans. The study used a two stage least squares method and three
different time spans ( 2 years, 5 years and 10 years) and the results showed that corruption
showed a significant negative relationship in the 5 and 10 year time span.
In contrast to these results, I introduce the second view towards corruption and economic
growth which is that corruption is beneficial. The rationale behind this view is that corruption
essentially mimics the role of institutions and greases the wheels of the economy. One of the
earliest supporters of this theory was Nathaniel Leff. His research led him to believe that
bureaucratic corruption is sometimes necessary to get around rigid business regulation.
Corruption is able to incentivize the creation of new and more efficient ways to conduct
business. Essentially, Leff is suggesting that corruption is a tool to get closer to an ideal free
market (Leff 1964).
This leads to an interesting study by Eatzaz Ahmad, Muhammad Aman Ullah and
Muhammad Irfanullah Arfeen (2012). Following the research of Mauro (1995), this study uses a
form of the growth model that is commonly seen when looking at developmental economics in
order to look at how corruption affects total factor productivity. Using education, foreign direct
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investment, population growth rate, bureaucratic efficiency, and a quadratic representation of

corruption, the regression implies a mostly positive relationship on growth. I say mostly positive
because once the country reaches a high enough level in bureaucratic efficiency, political
stability, institutional efficiency, and corruption control then, and only then, does corruption have
a negative effect on growth.
During the discussion of results from this study, an interesting point is brought up about
the causality between corruption and these various institutional factors. This causality has the
ability to undermine the significance of many regression results so its useful to not only review
literature that analyzes the relationship between corruption and growth but also review literature
in order to find the best variables to include and also which measure of corruption to analyze.
One paper published by Transparency International, does just this. According to
Lambsdorff (1999), research on the causes of corruption has been all over the place and hard to
pin down. This research commonly includes political institutions, social institutions, salary of
public employees, poverty and many other aspects. Lambsdorff goes on to say that within these
studies it is very difficult to determine whether corruption is affected by these variables or , in
fact, corruption is affecting these variables (Lambsdorff 1999). After an analysis of many
research articles on corruption, I conclude that the correlation effect will be unavoidable and
must be dealt with when analyzing the results.
Econometric Method

I.

Due to the general chaos surrounding this topic, there hasnt been a clear method to
tackle this question. However, after the literature review, the most interesting form of analysis
originally stems from Solow but was expanded by Barro (1990) and Mauro (1995). Barro takes
the endogenous growth model and reorganizes it in order to add conditioning variables. This
process begins here:
Cobb-douglas production function

Y = Total output of the economy

A = Total factor productivity parameter
K = Physical capital
L = Labor input
= Contribution of capital
1-= Share of labour
II.

If we derive the entire function above we end up with:

Where Fx is equal to the partial derivative of the particular variable. (FK=

Marginal product of capital and FL=Marginal Product of labor.)
III.

Divide the entire equation by L and convert eligible pairs into growth rates:

IV.

Simplify for cross-section analysis

(Solow 1957)
A few simplifications must be made in order to allow me to use this last model for
empirical analysis. The first is that factor productivity is going to be including many different
variables that may have some underlying effect on my labor or capital values. These variables
will be added to the equation as their own independent variable divided by L. The second
simplification is due to the fact that I am going to be using cross-sectional data at one point in
time. The growth will be log transformed and interpreted as magnitude.
Data Choice
The variables involved in this growth model are abstractions that arent easily defined
using available data. Instead I will use available statistics as representations of functions to find a
suggest a simplified relationship to analyze using an OLS model. In order to make this possible I
used proxy variables that were outlined by Barro (1990). GDP is the classic dependent variable
in production functions and growth. Government capital formation expenditure is used to mimic
K (physical capital) and research and development expenditure, corruption, expenditure on
education and foreign direct investment are used to represent a partial relationship to factor
productivity(A). All the variables besides Urbanization are divided by total labor force which
introduces the labor input, L, into the regression. In addition, I thought an additional control
would be useful so I decided to include urban growth as a control for development and
industrialization after reviewing the cross section analysis done by Nobuo Akai, Yusaku Horiuchi
and Masayo Sakata (2005).
In order to find a suitable sample size for analysis, I had to compile data from multiple
sources. Due to its large database and credibility, most of my data comes from The World Bank
database. After noticing a lack of information regarding research and development and education
expenditure, I was able to find both statistics in the UNESCO institutes database. These two
statistics from Unescos both had holes but I believe that these contained multiple years so I was
able to combine 2008-2013 and find the average which gave me 121 eligible countries my study.

I plan on taking a log of these two variables in order to only look at the effect of magnitude and
minimize multi-period variability.
For the sake of maintaining unity between databases, all of my financial variables were in
the form % Of GDP. Using GDP in current US dollars from The World Bank as a base, I
systematically calculated gross FDI, R&D, education expenditure and capital growth formation
for the 121 countries that possessed the proper data. Using these figures, I then divided these by
the total employed population (+15) to get the relative values per worker.
The only thing left was to decide the type of corruption index to use. According to the
Users Guide to Measuring Corruption, there are two main measures of corruption commonly
used, Transparency internationals CPI index and The World Banks Control of Corruption
indicator. Both have seen their fair share of time in research papers but I chose Transparency
International for it is much more sensitive than The World Banks Indicator and uses multiple
expert sources. This index involves a rating from 1-100 with 0 being very corrupt. To facilitate
discussion about my results, I decided perform a simple transformation and subtract the CPI
from 100 so that 100 is very corrupt.
In reference to my regression model the variables are defined as follows:

X1= Corruption perception index inverse (100-CPI)

X2= Foreign Direct Investment (Net inflows, $)
X3= Gross Capital Formation ($)
X4=Education Expenditure ($)
X5=Research and Development ($)
X6=Urban Growth (%)
C= Constant term
ui= Error Term
Y= Gross Domestic Product (GDP, $)
L= Employed Population (total workers)
After a simple correlation matrix check, I have concluded that my choices are adequate
although some have a correlation nearing, but not exceeding .8. As discussed earlier, Lambsdorff
(1990) outlines the many determinants of corruption that have been shown through empirical
research. The incidence of correlation between economic variables is an unavoidable hurdle that
needs to be dealt with in order to make any claims about causality. The correlation matrix values
I received lead me to believe there is no evidence of multicollinearity.

Empirical Results
Table-1: Descriptive statistics of the variables in the model and A Priori expected signs
Variable
s

Description

Mean

(Std
Dev.)

A Priori
Expected Sign

Obs.

GDPper

Gross Domestic Product

per worker

34579.0942

(39226.9
5)

CapFor
m

Gross Capital Formation

($)

138512.254
3

(376811.
96)

121

FDI
inflow

Foreign Direct Investment

per worker (Net inflows,
$)

4356.40359
8

(29176.2
83)

121

EduExp

Education Expenditure
per worker ($)

1841.00592
8

(2250.44
)

121

R&D

Research and
Development
expenditure per worker
($)

634.747373
8

(992.34)

121

UrbGro
w

Urban Growth (% change)

1.82956256
3

(1.946)

121

iCpiper

Corruption Perception
Index inverse per million
workers (100-CPI)

15.0267420
4

(20.32)

121

121

Descriptive statistics
Table 1 shows the statistics of the average country as described by the choice variables.
All of these variables sans urban growth are defined as per worker in order to fit into my
empirical model and dollar amounts are in current U.S. dollar. The typical per worker GDP of a
country in this study is 34579 dollars. The government of the typical country spends $634.74 on
R&D and $138512.3 per worker. For the sample, the average country is experiencing a 1.8%
growth in urban population which for context, is around %1 in the United States, Canada and the
U.K. and around 4-5% in developing nations like Bangladesh, Chad and Ethiopia. The typical
country invests $138,512 towards capital formation per worker. Capital formation is comprised
of additions to fixed asset of the domestic economy such as infrastructure, equipment purchases
and inventories. This statistic has a huge standard deviation due to the massive capital formation
of the US and Japan but a log transformation will allow this data to be beneficial for the
regression. An average country receives $4356.40 worth of foreign direct investment per worker
which is a component of total factor productivity. The CPI statistic from the table represents the
concentration of perceived corruption per worker. The typical country experiences a
concentration of 15, which is fairly high per worker concentration on a scale of 1-100.

Does corruption affect economic growth?

Table2- Regression of log GDP per worker on various indicators of economic growth
Dependent variable= logarithm of GDP per worker
Variables

Coefficient
s

Significanc
e

0.4774

(0.2523)
logCPI

0.4591

***

(0.0652)
logFDI

0.05004

**

(0.024)
logCap

0.4563

***

(0.0626)
logEDU

0.3191

***

(0.0461)
logR&D

0.1658

***

(0.0297)
UrbGrow

-0.01544

(0.00893)
R Square

0.96619627

F-Value

385.864208

Adjusted R
Square

0.96369229

Significance
F

2.1844E-57

Obs

121

Parentheses denote standard error, *** p<0.01, ** p<0.05, * p<0.1

Using the endogenous growth model as the base of my econometric method, I performed
a log transformation of all variables besides urban growth. This log relationship present in the
growth model allowed me to effectively regress variables which show evidence of outliers
without omission which would be a dishonest regression in this case. In addition, according to
the method outlined Egunjobi (2013), all variables besides urban growth are measured per

worker. However, in order to avoid sounding repetitive, I will omit the per worker description
while discussing my results.
The first characteristic to look at is corruption levels in order to determine whether or not
to reject the null. The null hypothesis was that corruption level The logarithm of corruption per
worker significant at the 99% level. The log-log nature of this model makes the relationships
between variables very clear and presents them as elasticities. Holding all else constant, a 1
percent increase in corruption per worker would lead to a .459 percent increase in GDP per
worker.
This result is made stronger with the inclusion of my other explanatory variables. These
variables were meant to test the true effect of corruption concentration on GDP by isolating
factors of physical capital and factor productivity that could be misattributed to corruption.
Urban growth and the constant term significant at the 10 percent level, the logarithm of foreign
direct investment is significant at the 5% level and the rest of my variables (Capital formation,
education expenditure, research and development) or significant at the 1% level.
In addition, the coefficients of my variables make logical sense. Ceteris paribus, a 1%
increase in formation of capital expenditure is associated with fairly large .456% increase in
GDP per person which makes sense given that it is the main representation of physical capital
within my model. The elasticity of education expenditure and research and development, which
are widely touted as determinants of factor productivity, had elasticities of .319% and .165%
respectively. The inclusion of urban growth was use to provide a parameter of level of
development and its value matched my A Priori expectation. I expected growth to be inversely
correlated with GDP per person because the nations with the highest rates of urban growth are in
nations in developing stages. With the addition of each variable in the growth function,
corruption per worker maintained its significance. This gives me reason to believe that
corruption does have a role in total factor productivity.
I find this result interesting because it is the opposite of my a priori expected sign. I
thought that the concentration of corruption would mimic values found by Ahmad (2012) and
Egunjobi (2013) but instead I found a growth enhancing property which was closer to the view
held by Leff (1964).
Conclusion and Policy Implications
After analyzing my final regression data, I come to a few conclusions regarding
corruption. According to the data, regression is not the huge hurdle to development that is
suggested by the World Bank and International Monetary Fund. In fact, alongside capital
formation, corruption perception concentration exhibited the largest elasticity in relation to GDP
per worker. This leads me to believe that this grease money concept proves to have merit.
Corruption may indeed allow people to avoid bureaucratic regulation and create an illegitimate
free market.
In regard to policy, this data suggests less emphasis on corruption control. Instead of
putting scarce government resources into controlling corruption, the regression suggests
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allocation these resources into capital production, which increases the physical capital portion of
the growth model. Beneficial policies could include any investment into education or research
development which would improve factor productivity.
It is important to note that although, corruption per worker is statistically significant, the
leaders in GDP per worker maintain a low corruption concentration. These outliers imply once a
country reaches a certain level of economic prosperity, corruption seems to dissipate. This brings
back the work of Lambsdorff (1999) and his concern about the causality between corruption and
growth. While my regression doesnt include enough depth to address causality, I believe that the
results do imply that a focus on aspects other than corruption control and that growth may in turn
lessen corruption.
Limitation of Regression
Initially, the analysis of corruption on economic growth seemed like a manageable topic.
However, after just a few articles from my literature review, I could tell that I was going to run
into problems. The first thing I noticed was that all of these studies were using different
corruption estimators. This is because corruption is such a fleeting thing to measure. Corruption
closely follows a crime model (Ahmad 2012) and one characteristic of the crime model is that it
is hidden by nature. Also, its hard to decide what activities are classified as corruption. Because
of these difficulties, the most popular method of corruption measurement is by using perception
surveys. By using a measure of perception rather than a concrete measure, I feel my regression is
under the influence of social and cultural bias.
A huge limitation of my regression comes from a limit of my knowledge. Economic
growth is dynamic and I wasnt able to figure out a multiple period model given my current
econometric understanding. Instead I looked at statistics for percentage growth in multiple
databases in order to try to make a static model with some dynamic components but the growth
percentage data was very limited in scope. I also believe my model could have been improved if
during my derivation of the Cobb-Douglas function I divided by Y instead of L which would
have gotten me closer to the true Solow Residual equation (Solow 1957).
My knowledge is also limited when dealing with heteroscedasticity of cross-section data.
There is reason to believe that my regression suffers from heteroskedastic. I tried different
variables and data sources but I still found evidence of heteroscedasticity. After doing a little
research into heteroscedasticity, I have found that single-period cross-section data sometimes
suffers from this error. Due to limited data, I wasnt able to increase my sample size to try and
remedy this issue either. I contemplated doing a weighted least squares regression but feared that
my knowledge was not sufficient enough to fully explain my choice of regression weights.
Another limit within my regression is that I did not use any interaction variables. My
research isnt completely destroyed by this omission but, given the strange causality relationship
between economic indicators and corruption, I think I could have furthered my research by
including interaction relationships between corruption and FDI or education expenditure.

Researchers that believe corruption hinders growth often cite an inverse relationship between
corruption and investment or education and this further analysis could investigate this point.
The last limit to my regression was the lack of grouping countries. As discussed in the
descriptive statistics, there are some definite outliers regarding the richest countries. I still
believe my regression was useful to look at the relationship as a whole but I predict that
corruption is much more of an issue in lower-income countries. However, I believe a simple 1/0
dummy variables would over simplify this relationship and I am not sure how to make or
interpret a regression with over 2 groupings.

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Works Cited
Ahmad, Eatzaz, Muhammad Aman Ullah and Muhammad Irfanullah Arfeen (2012), Does
Corruption Affect Economic Growth? Latin American Journal of Economics, Vol. 49, No. 2, pp.
277305.
Akai, N., Horinchi, Y., Sakata, M., Short-run and Longrun Effects of Corruption on Economic
Growth: Evidence from State-Level Cross-Section Data for the United States, CIRJE F 348,
http://www.e.ntokyo.ac.jp/cirje/research/
Barro R (1990). Economic Growth in a Cross-Section of Countries. Quarterly J. Econ. 106: 407443.
Egunjobi, Adenike T. (2013), An econometric analysis of the impact of corruption on economic
growth in Nigeria. Journal of Business Management and Economies, 4 (3), 054-065
Kaufmann, D. and S.-J. Wei (1999), "Does 'Grease Money' Speed up the Wheels of Commerce?"
National Bureau of Economic Research Working Paper 7093, Cambridge MA.
Lambsdorff, J.G. (1999), "Corruption in Empirical Research - A Review," Transparency
International Working Paper, Berlin.
Leff, N. (1964), Economic development through bureaucratic corruption, American
Behavioral Scientist, 8(2):814.
Mauro, P. (1995), "Corruption and Growth", Quarterly Journal of Economics, CX, 681712.
Solow, R. M. (1957), " Technical Change and the Aggregate Production Function," Review of
Economics and Statistics, 39 : 312-320

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