Economics of corruption

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Economics of corruption deals with the misuse of public power for private benefit and its economic impact on society. This discipline aims to study the causes and consequences of corruption and how it affects the economic functioning of the state.

Economies that are afflicted by a high level of corruption are not capable of prospering as fully as those with a low level of corruption. Corrupted economies cannot function properly since the natural laws of the economy are distorted. As a consequence, corruption, for instance, leads to an inefficient allocation of resources, poor education, and healthcare or the presence of a shadow economy - which includes illegal activities and unreported income from legal goods and services that should be taxed but are not.^[1][2]

One of the challenges of studying corruption lies is its definition. This might appear as a minor detail, but how we define corruption affects the way we model it and how we measure it. Although there are many definitions of what corruption is, most of them overlap over the central issue - "the misuse of public office power for personal gain in an illegal manner". Certain illegal activities such as fraud, money laundering, drug trade, and black market operations, do not necessarily amount to corruption if they do not involve the use of public power (bureaucracy).^[3][4] Another viable definition is as follows: corruption is an “arrangement” that involves “a private exchange between two parties (the ‘demander’ and the ‘supplier’), which (1) has an influence on the allocation of resources either immediately or in the future, and (2) involves the use or abuse of public or collective responsibility for private ends.”^[5]

The pervasiveness of corruption is a probabilistic measure and refers to the likelihood that an entering firm will encounter corruption in its dealings with government officials or politicians in the host country. A high level of pervasiveness indicates that firms are more likely to encounter corruption when undertaking normal business activities.^[6]

The study distinguishes two types of corruption: 1. Extortion: The demand of an official for a bribe under threat of harmful actions, or put him in such conditions under which he is forced to give a bribe in order to prevent harmful consequences for his law enforcement interest. 2. Collusion: When an authorized person takes a bribe for something they should not do, with both parties interested in the outcome.

The real damage from such corruption is often difficult to measure and can be many times more than officially reported figures.

Research on corruption faces a significant empirical obstacle – measurement. Corruption, by its nature, is illicit and secretive. Large portion of corruption is never discovered or prosecuted.^[7] Despite this challenge, researchers have made progress in addressing the level of corruption by attempting to measure the perception of corruption, rather than corruption itself.^[4]

As such, one way to objectively measure corruption is by counting the number of criminal indictments for corruption. However, this can be ineffective due to the fact that the ratio of indictments to actual corruption may be highly variable. Often corruption goes unpunished and is thus not counted in this measure. Subjective measures, typically curated via survey data, may be a useful tool to measure corruption. Comparisons between countries may be more comprehensive and consistent, though a fair amount of bias is present in this data as well due to the nature of the subject it measures.

The International Country Risk Guide^[8] is a survey of firms on the likelihood they will be asked to make illegal or extralegal payments. The Corruption Perceptions Index^[9] is a detailed survey incorporating data from many nations and groups. Finally, the World Bank produces an annual "control of corruption" index that uses similar sources to the International Country Risk Guide and Corruption Perception Index.^[10][11]