STRATEGIES FOR REDUCING CORRUPTION AND INCREASING INVESTMENT AND GROWTH

Higher wages for public sector officials can reduce corruption and improve the enforcement of property rights in many developing and transition economies, hence making investment in the private sector more profitable. According to Daron Acemoglu and Thierry Verdier, writing in the September issue of the Economic Journal, this greater level of private sector activity can in turn generate more tax revenue, enabling the government to pay the higher public sector wages without imposing higher tax rates.

Acemoglu and Verdier also suggest that there may be an optimal level of corruption and property rights enforcement, trading off the costs and benefits to society. But this optimal level may vary considerably across countries, which may explain why many less developed economies ‘choose’ to tolerate more corruption and lower levels of property right enforcement. However, there are many reasons for governments to choose too little property rights enforcement and allow too much corruption - and many are unlikely to be for the benefit of society as a whole.

The researchers note that per capita income in the US is 30 times as high as in some of the world’s poorest countries. Many economists now believe that differences in economic institutions are partly responsible for these large income disparities. Wealth creation will be limited in countries where investments are not properly rewarded. Weak property right enforcement and widespread corruption are therefore likely to be important in generating the large income differences we observe across nations.

There are also numerous anecdotes about how insecure property rights and high bribes discourage investment in many less developed countries. These views receive further support from findings of negative correlation between measures of corruption and growth rates across countries.

The amount of corruption and the degree of property right enforcement are also partly chosen by the society, however. Higher wages for public sector officials would reduce corruption and improve the extent of property rights, since these officials then have more to lose if they get caught taking bribes. However, a strategy of high public sector wages may result in high taxes, and attract many talented individuals to the public sector, even though they could have been more productive in the private sector.

There may therefore exist an optimal level of property rights enforcement and corruption, trading off the costs and the benefits. Less developed countries, where returns to investments may be lower due to other reasons, for example scarcity of skills, may choose lower levels of property right enforcement. They may also choose to tolerate more corruption.

This argument does not, however, imply that the amount of corruption we observe in many less developed countries is optimal. On the contrary, there are many reasons for governments to choose too little property rights enforcement and allow too much corruption.

In fact, it is possible that, in some cases, increasing public sector wages may provide a ‘free lunch’ to society:

Higher wages discourage bribes, making investment in the private sector more profitable.
This encourages many talented individuals to stay in the private sector where prospects are now improved.
Furthermore, this greater level of activity in the private sector could also generate more tax revenue, enabling the government to pay the higher public sector wages without imposing higher tax rates.
Here lies a problem for outsiders trying to evaluate government policy: an increase in public sector wages may be part of a strategy of reducing corruption and increasing investment; or it may be an attempt to take a larger share of national income by the politicians and their allies. Case-by-case analyses are therefore necessary to evaluate government policies against corruption and the optimal amount of property right enforcement.

Note for Editors: ‘Property Rights, Corruption and the Allocation of Talent: A General Equilibrium Approach’ by Daron Acemoglu and Thierry Verdier is published in the September 1998 issue of the Economic Journal. Acemoglu is in the Department of Economics at Massachusetts Institute of Technology (MIT), 50 Memorial Drive, Cambridge, MA 02142-1347, USA; Verdier is at DELTA in Paris.

For Further information: contact RES Media Consultant Romesh Vaitilingam on 0117-983-9770 or mobile 0468-661095 (email: romesh@compuserve.com); or Daron Acemoglu on 001-617-253-1927 (home: 001-617-723-1927; fax: 001-617-253-1330; email: daron@mit.edu)