Social sectors in an economy are often characterized by market failures. To correct such failures, governments intervene through the public provision, financing, and regulation of services. There is recognition that corruption emerges as a by-product of government intervention (Acemoglu and Verdier 2000); what is not well understood, however, is that corruption can adversely affect the provision of publicly provided social services. The theoretical literature identifies three channels through which this can happen. First, corruption can drive up the price and lower the level of government output and services (Shleifer and Vishny 1993), including the provision and financing of health care and education services in many countries. 1 Second, corruption can reduce investment in human capital (Ehrlich and Lui 1999). Finally, corruption can reduce government revenue (Shleifer and Vishny 1993; Hindriks, Keen, and Muthoo 1999), which in turn can lower the quality of publicly provided services (Bearse, Glomm, and Janeba 2000). 2 The latter discourages some individuals from using these services and reduces their willingness to pay for them (through tax evasion), which shrinks the tax base and diminishes the government's ability to provide quality public services. 3 The lower quality also creates incentives for individuals to opt for privately provided services. However, in countries where private markets for health care and education services are limited, this can lead to congestion, increased delays in obtaining public services, rising opportunities for rentseeking, and frequent use of discretionary power by government officials. Even in cases where private markets are well developed and extensive, the poor may lack the ability to pay for private services and outputs.
These predictions are consistent with a growing empirical literature on the economic consequences of corruption as well as results from surveys of users of public services. The existing empirical evidence, for example, shows that corruption reduces spending on operations and maintenance, such as medicine and textbooks (Tanzi and Davoodi 1997). Higher corruption is associated with rising military spending (Gupta, de Mello, and Sharan