Corruption is a value-loaded term, defined in many different ways in the literature (e.g., see Klitgaard, 1988, and Gong, 1994). Rather than add to the long list of definitions, this paper identifies salient characteristics of corruption and analyzes their implications. Three aspects of corruption are particularly important: (i) It is a rent-seeking activity induced by deviation from the perfectly competitive market. (ii) It is illegal. (iii) It involves some degree of power, which can be interpreted as a form of human capital acquired through inheritance or investment.
I. IMPERFECT MARKET
Corruption occurs in all countries, irrespective of whether they are rich or poor, dictatorships or democracies, socialist or capitalist. What common elements can cause corruption in these diversified environments? There may be many factors that affect the level of corruption. However, if the resource allocation system is perfectly competitive, then corruption cannot exist.
Imagine that an official has the authority to allocate a commodity at a price below the market equilibrium level. Then rent seeking may occur and the official may be able to accept bribes. On the other hand, if the price of the commodity is already at the equilibrium level, corruption will not take place. The official may be greedy, but people who can buy the good elsewhere at the competitive price have no incentive to pay him extra money.
Deviation from the competitive market caused by government regulations or interference is a major cause of corruption. Myrdal (1968, Chapter 20) pointed out that many less developed countries have very high levels of corruption. Also, well known is that in centrally planned economies, such as the former Soviet Union and China, corruption is widespread (see, for example, Simis, 1982; Yu, 1993). A common feature for these countries is that their market mechanisms are heavily distorted. Within a country, corruption is most common in government-controlled activities that are not guided by market forces. For example, before the establishment of the rather effective Independent Commission Against Corruption (ICAC) in Hong Kong in the 1970s, the police force there was the main target of public complaints about corruption. Since non-market resource allocation is present in every country, corruption is pervasive throughout the world.
Interference with the free market usually induces inefficiencies. However, bribes sometimes can partially restore the price mechanism and improve allocative efficiency. Corruption then might be viewed as people's optimal response to market distortions. In this sense, corruption has some beneficial effects to society, but the resulting solution is only second-best. This view, which has been shared by many researchers - e.g., Leff (1964), Huntington (1968) - and formally supported by Lui (1985) in a more general context, recently has been challenged by Mauro (1995). Mauro has shown that after controlling for the level of per capita real GDP, an increase in corruption lowers investment. However, it is not clear that this is inconsistent with the efficiency result of corruption. Countries with highly distorted markets tend to have high levels of corruption. The distortions rather than corruption may be the principal deterrent to investment in physical capital.
In either case the net effect of corruption is not necessarily beneficial to society. Corrupt officials who believe that the free market system can uproot their profit-making opportunities will resist economic reforms. An example is the tremendous difficulty in liberalizing the interest rate to the competitive level in the process of reforming the banking system in China. I will also argue in Section III that corruption lowers the long-run economic growth rate of a country.
II. THE ILLEGALITY OF CORRUPTION
Corruption generally is regarded as illegal. This implies that in many cases, corrupt activities have to be kept secret. …