UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE EFFECT OF CORRUPTION ON
ECONOMIC GROWTH IN ASIAN COUNTRIES

BY

LE KIM DUNG

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, Dec 2016


UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS


II. ACKNOWLEDGEMENT
I would like to express my gratitude to interesting and extensive Vietnam–
Neitherlands Master Program in Development Economics, as well as honest thanks
to many people who built and developed this program such as management board,
lecturers, tutors, and librarians. Fulfillment this course, I acquired useful
knowledge, approached new things, were straightforward to expess ideas.
I would like to extend my special thanks to Dr. Truong Dang Thuy, the academic
supervisor who always read and correct my thesis carefully. His valuable
comments, guidances, and encouragement help me to improve the quality of my
thesis and complete it timely.
I also would like to take this opportunity to express my thanks to Dr. Nguyen Trong
Hoai, Dr. Pham Khanh Nam, other professors, tutors and course co-instructors of
Economics University who, through their valuable lectures and advices, help me
during the course.
Finally, many thanks and gratefulness are given to my dear family, my warm
friends for their encouragement in many ways that strongly support me during my
study stage.


III. CONTENTS
Certifications………………………………………………………………………………..

I

Acknowledment...................................................................................................................... II
Contents…………………………………………………………………………………

III

List of tables………………………………………………………………………………. IV

4.2.2 Effects of corruption on economic growth indirectly through transmitions
channels .................................................................................................................................... 44
CHAPTER 5: CONCLUSION, LIMITATION AND FUTURE RESEARCH ................. 52
5.1 Conclusion ......................................................................................................................... 52
5.2 Limitations and future research ......................................................................................... 52
5.2.1 Limitations ................................................................................................................ 52
5.2.2 Suggestion for future research .................................................................................. 53
REFERENCES…………………………………………………………………….…...55
APPENDIX
Appendix A : Summary of empirical studies………………………………….…….63
Appendix B : Sample of countries.………………………………………………….68
Appendix C : Regression results…………………………………………………….69


IV. LIST OF TABLES
Table 1: Expected sign of selected variables………………………….………….……….25
Table 2: Model specification of growth and transmission channel equations……….……29
Table 3: Summary of Variables ……………………………………………….…………32
Table 4: Descriptive statistics and correlations of selected variables………….………….36
Table 5: Correlations of selected variables…………………………………….………….37
Table 6: Results of Pooled OLS, Fixed effect model (FEM), and Random effect model
(REM) in GDP regression model (Model 1)………………………………………………42
Table 7: Results of 3SLS regression in a system of structural equations…………………46
Table 8: Consequence of Corruption on Economic growth through transmission
channels………………………………………………………………………………..…..47


V. LIST OF FIGURES
Figure 1: The effect of Corruption on Economic growth………………………………….21
Figure 2: Scatter graph between Economic growth (GDP) and Corruption (CPI)………...37

instability, government expenditure, openness to trade.

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CHAPTER 1: INTRODUCTION
1.1 Research problem
During the past few decades, various researchers have tried to identify what are the
most important determinants of economic growth, and why some nations have
experienced quick long-term income growth rates while others have not. A
fundamental cause for this study is the lack of a final agreement about the engine of
growth because there are many factors that influence the development of the
economy. Indeed, two most popular growth theories, the neoclassical growth theory
by Solow (1956) with the cruciality of investment activities and the endogenous
growth theory by Romer (1986) and Lucas (1988) focusing on labor and the
capacity of innovation lead to various extensions and country developments later.
These developments raise a big discussion about the most important sources of
growth. While some researchers refer to factors such as labor, capital, investment,
technological progress, government spending, and openness of trade economic
freedom; the others are referring to institutions, democracy, rule of law, geography
factors, and corruption.
In searching for the important growth determinants, a lot of economists focus on
corruption, for example, Left (1964), Becker (1968), Lui (1985), Manion (1996),
Kaufmann and Wei (1999), Haque and Kneller (2009), Mohamed Dribi (2013),
Diaby and Sylwester (2014), Pak Hung Mo (2014). Even then, their lituratures have
not approached to the last concord about the effects of corruption on economic
growth. Some papers stated that with a suitable level of corruption, the correlation
between corruption and economic development is positive. In the country that has

the author found that corruption affects the economic growth negatively. The
empirical result indicated that one point increased in the corruption index will
generate 0.9 percent decreased in the annual growth rate via human resources,
government spending, investment, inflation, political condition, and openness. The
paper futher concluded that human resources and political situation are the most
crucial transmission channel through which corruption transmits its negative impact
on economic growth. Unlike Mohamed Dridi, Mo (2001) used the decomposition
method and found that the political instability accounts for 53 percent of the total
corruption effect on growth. Furthermore, using cross-coutry regression, Mauro
(1996) showed the strong negative effects of corruption on growth in 94 countries
with observations period from 1960 to 1985. Mauro (1996) concluded that

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corruption reduces investment, especially in private sector, and declines the
government expenditures in developing education seen as the vitual element of
growth. With the data from Global Competiveness Report Serveys in the year 1996
and 1997, based on Stackelberg game theory, Kaufmann and Wei (1999) checked
the relationship between bribe payment and effective bureaucratic molestation.
They found that no evidences support for the “speed money” hypothesis, expressed
differently, they refuted “efficient grease” thesis, so corruption reduces economic
growth.
Besides, the correlation between corruption and economic growth is still uncertain
in some findings from previous papers (Andvig and Moene, 1990; Ehrlich and Lui,
1999; Aidt et al, 2008; Haque and Kneller, 2009; Leite and Weidmann, 1999). By
employing Threshold model with 54 developed and developing countries data set
observed from 1980 to 2003, Haque and Kneller (2009) stated about Threshold

-

Does corruption impact (promote or impede) the economic growth in Asian
countries directly and indirectly?

-

How are corruption effects on economic growth via five possible transmission
channels:

investment,

human

capital,

political

instability,

government

expenditure, and openness to trade.
1.3 Thesis Structure
This thesis is divided into five chapters.
Chapter 1: Introduction presents numerous conclusions about the correlation
between corruption and economic growth from various theoretical and empirical
researches. Besides, it explains what vital objectives are, what research questions
should be raised to answer in this paper.
Chapter 2: Literature review provides a general review of economic theories

Chapter 4: Empirical Findings focuses on presenting the estimation results about
influences of corruption on growth.
Chapter 5: Conclusions, Limitation and Future research comes to the main
findings achieved in the previous chapter. Accordingly, this part points out the
limitations and further studies concerning the relationship between corruption and
economic growth..

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CHAPTER 2: LITERATURE REVIEW
2.1 Theoretical concepts related to economic growth and corruption
Definition of economic growth
Economic growth is an expansion in productive capacity of commodities and
services, and average national income level in a period of time, compared with an
another period (Perkins et. al., 2006, p. 12)
In comparison of economic growth from two countries, Gross Domestic Product
(GDP) or Gross National Product (GNP) are in common use. GDP and GNP can be
caculated in nominal denomination, which includes inflation, or in real
denomination, which is adjusted inflation.
Theories of economic growth
Despite the absence of a dominant theory, almost all economic growth researches
argue that differences in level of income across the countries around the world are
due to differences in factor endowment, factor productivity, technology, the
combination of any two factors, or all the above.
In the first growth theory, and perhaps the most popular theory, Solow (1956) found
that capital has less contribution to economic growth than expected, leaving a large
residual unexplained, even after taking account for effective labor.

the misuse of entrusted authority for extra positive personal benefit (Transparency
International website).
In term of typology, corruption divided into three categories as grand corruption,
bureaucratic corruption and political corruption determined by the sector where it
happens and how much money paid off.
-Grand corruption (nearly the same meaning as political corruption)
comprises about activities involving high level of public area that falsify
government policies or the central operating of the nation. This kind of corruption is
centralized and can affect all citizens in the country.
-Bureaucratic corruption (or petty corruption) refers to the small amount of
money which ordinary citizens pay for public bureaucrats to access basic
commodities or sevices in places like public hospitals, schools, police departments,
licensing authorities, taxing authorities, and other agencies. This type of corruption
has also been called “low-level” or “street-level” corruption. It is decentralized that

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the exact bribes taken are not arranged. It just makes bureaucrats speed up the
procedure or skip legal penalties.
-Political corruption is defined as the situation in which political decision
makers abuse their position to influence policies, organizations and processes in the
allocation of public resources and investment in order to strengthen their
jurisdiction, position and wealth. This type of corruption is also considered as
having impact on the result of election voted by legislators.
In term of measurement, the most popular corruption measures used in most
empirical researches are the Corruption Perception Index (CPI), Bribe Payers Index
(BPI), Global Corruption Barometer (GCB), and National Intergrity System

culture (tariff on a good, restrictions on import, quota on import), the misallocation
of resources makes a deadweight loss in which no-one can obtain surplus and social
benefits decrease. Higher price leads to lower output. It means economic growth
reduces.
-

Queue Model:

Queueing theory was developed by Agner Krarup Erlang in 1909. This model is
constructed to predict queue lengths and waiting time for a good or service. This
model applied for companies, shops, offices, and hospitals. Lui (1985) developed
this model to illustrate the circumstance in which bureaucrats issue business
licenses to firms and grant privileged treatment to people who suborn the relevant
administrators in order to expedite the proceduces. For example, if business entity
would like to establish a company or set up a factory, there paperwork would be
reduced and a license will be granted quickly and easily through bribery. It can
express differently, corruption has a positive relationship with the growth rate.
-

Transaction Cost Theory:

Lambsdorff (2002) metioned that transaction cost of legal contract include seeking
partners and information costs, bargaining and determining appropriate contract
condition costs, policing and enforcement of contract term costs. These costs of
corruption agreements needs to be concealed. So, most corrupt contracts are
discussed through broker.
Lambsdorff (2002) also mentioned that if parochial corruption exists in a market to
trade goods and services, the total transaction cost will rise because there need to be
more expenses to find potential contractors. The accelerating costs come from
searching potential partners, quality appraisal, product and individual ability

decisions favourable to growth. Lien (1986) with Competitive bribery game and Lui
(1985) with Equiblirium queuing model also suggested that corruption may be
enhance economic growth.
In contrast, the concern about the bad impacts of corruption on economic growth
has increased rapidly in both developing and developed countries. Various
empirical studies have shown up on this issue, including Mauro (1995), Tanzi
(1998), Aidt (2003), Akai N. et al (2005), Boris P. et al (2008). These studies

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suggested that private firms who win government’s contracts by high paying are not
necessarily economically competitive firm and such un-optimal use of human
resource will destroy economic growth. Moreover, private companies were often
forced to make side-payments to corrupted government officials and that cost was
often huge for small-scaled but emerging firms, which can be the driving force for
growth of the economy.
With the dataset of 21 Africa countries covering the period 1993-1999, Kwabena
Gyimah-Brempong (2002) modified the growth equation in a linear form include
corruption as an independent variable:
g = αo + α1k + α2edu + α3x + α4corrupt+α5y0 +α6govcon + εi
where: g: rate of economic growth of real income (dependent variable)
εi : stochastic error term
αi: coefficients to be estimated
k (investment rate), edu (educational ettainment of the adult population), x
(growth rate of real export), corrupt (corruption), govcon (government
consumption), yo (initial level of income) are explanatory variables
Employing OLS regression method, Kwabena Gyumah-Brempong (2002)

2.3.2 The system of equations approach.
Applying the system of equations approach to check the direct and indirect effect of
corruption on the economy, a numerous papers stated that corruption has a negative
impact on economic growth such as Pak Hung Mo (2001), Pellegrini and Gerlagh
(2004), Lorentzen, Mc Milan and Wacziarg (2008), Pellegrini (2011), Marie Chene
(2014), Campos et al., (1999), Mohamed Dribi (2013). The typical system of
equations is specified as below:
Direct effect: GDP = f(CPI, TV) (named as equation 1a, 1b)
Indirect effects: TV = f(CPI, GDP) (named as equation 2a, 2b)
where TV presents other determinants of economic growth

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2.3.2.1 Direct effects of corruption on economic growth
Pellegrini and Gerlagh (2004) modeled the direct relationship between economic
growth and corruption as follows:
Gi = αo + α1ln(Yoi) + α2Ci + α3Zi + εi (equation 1a)
Where:

Gi : dependent variable, represented by GDP growth rate per year
covering the period from 1975 to 1996, Gi = (1/T)ln(YTi/ Yoi)

ln(Yoi) : independent variable, represented by the logarithm of the degree
of initial income with negative coefficient, α1 < 0.

Ci : explanatory variable, represented by corruption which measures
the extent of bribes and bribes asking in one country from 1980

These figures extracted from the Natural Resource Abundance
and Economic Growth database.

εi : denoted as Error term

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i, t : Country i and time t respectively
With above model, Pellegrini and Gerlagh (2004) regressed the data set of 48
countries covering the period 1965-1996 and got the results. The coefficient for
corruption is negative and equal to 0.07 (decrease almost to zero). It means the
direct effect of corruption on economic development is negative, insignificant, and
insubstantial. Pak Hung Mo (2001) examined the correlation between corruption
and growth via the model below:
GR = F (CORRUPT, y70, PRIGHT, PRIGHT2, HUMAN, INSTAB, IY, POPG)
(equation 1b)
Where

GR : Growth rate of real GDP in percentage
CORRUPT : Corruption index
y70 : The initial per capita of national income
PRIGHT : The Gastil index of political rights
HUMAN : Average years of schooling in the total residents over the age of
twenty five from 1970 to 1985
INSTAB : Measure of political instability
IY : Ratio of private investment to GDP
POPG : Rate of population of one country growth

Where:

Zi : represented the impact of corruption on the vector of dependent
variables: investment, schooling, openness of international trade,
political instability

ln(Yoi) : represented by the logarithm of the degree of initial income
Ci : described by corruption
βo, β1, β2 : four-dimensional vectors of coefficients
µi : denoted as the vector of residuals
To control endogeneity of the corruption variable through 2SLS regression, Mo
(2001) used continental dummies (dummy for East Asian countries, dummy for
Latin-American countries, dummy for OECD countries, dummy for Sub-Saharan
African countries) and ethnolinguistic fractionalization while Pellegrini and Gerlagh
(2004) used legal origins as instrumental variables. Legal origins in this research is
defined as a set of dummy variables that characterize the countries as Scandinavian,
French, English or German. Furthermore, to test robustness, Pellergrini and Gerlagh
also added some other independent elements such as regional dummies, democracy
indexes, OECD dummy to OLS regression.

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2.3.2.2.1. Investment
Mello (1997), Bengoa and Robles (2003) stated that investment boosts up the
economic growth. However, corruption discourages domestic and foreign direct
investment (FDI) because of additional transaction costs in conducting targeted
project. Most studies proved that corruption has a negative relationship with