consequences of corruption

From economic theory, one would expect corruption to reduce economic growth by lowering incentives to invest (for both domestic and foreign entrepreneurs). In cases where entrepreneurs are asked for bribes before enterprises can be started, or corrupt officials later request shares in the proceeds of their investments, corruption acts as a tax, though one of a particularly pernicious nature, given the need for secrecy and the uncertainty as to whether bribe takers will live up to their part of the bargain. Corruption could also be expected to reduce growth by lowering the quality of public infrastructure and services, decreasing tax revenue, causing talented people to engage in rent-seeking rather than productive activities, and distorting the composition of government expenditure (discussed below). At the same time, there are some theoretical counterarguments. For example, it has been suggested that government employees who are allowed to exact bribes might work harder and that corruption might help entrepreneurs get around bureaucratic impediments.
One specific channel through which corruption may harm economic performance is by distorting the composition of government expenditure. Corrupt politicians may be expected to spend more public resources on those items on which it is easier to exact large bribes and keep them secret--for example, items produced in markets where the degree of competition is low and items whose value is difficult to monitor. Corrupt politicians might therefore be more inclined to spend on fighter aircraft and large-scale investment projects than on textbooks and teachers' salaries, even though the latter may promote economic growth to a greater extent than the former.
Empirical evidence based on cross-country comparisons does indeed suggest that corruption has large, adverse effects on private investment and economic growth. Regression analysis shows that a country that improves its standing on the corruption index from, say, 6 to 8 (0 being the most corrupt, 10 the least) will experience a 4 percentage point increase in its investment rate and a 0.5 percentage point increase in its annual per capita GDP growth rate (Mauro, 1996). These large effects suggest that policies to curb corruption could have significant payoffs. The association between corruption and low economic growth remains broadly unchanged when estimated for a group of countries with extensive red tape. Therefore, there is no support for the claim that corruption might be beneficial in the presence of a slow bureaucracy. The most important channel through which corruption reduces economic growth is by lowering private investment, which accounts for at least one-third of corruption's overall negative effects. At the same time, the remaining two-thirds of the overall negative effects of corruption on economic growth must be felt through other channels, including those mentioned above. While it is difficult to disentangle those other channels, there is some evidence that one of them--the distortion of government expenditure--plays a significant role.
Based on cross-country comparisons, it seems that corruption alters the composition of government expenditure: specifically, corrupt governments spend less on education and perhaps health, and probably more on public investment. Regression analysis shows that a country that improves its standing on the corruption index from 6 to 8 will typically raise its spending on education by 1/2 of 1 percent of GDP, a considerable impact. This result is a matter for concern, because there is increasing evidence that educational attainment fosters economic growth.