DP5281 Developing Rotten Institutions

Author(s): Morgan Kelly
Publication Date: October 2005
Keyword(s): corruption, growth
JEL(s): O17, O40
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5281

This paper models corruption as optimal parasitism in organizations where teams of agents are weakly restrained by principals. Each agent takes on part of the role of principal, choosing how much to invest in policing to repress corruption in others and how rapaciously to act when unpoliced opportunities arise. This simple model can incorporate many factors stressed in empirical analyses of corruption, and gives rise to a wide variety of equilibria. Allowing income to co-evolve with corruption, we show how adding corruption to a textbook exogenous growth model leads to a Lucas paradox. When income and corruption affect each other sufficiently strongly, economies converge to two corner equilibria despite diminishing returns to capital: a rich, clean corner and a poor, corrupt one; a pattern that appears to characterize international data.