If you are interested in the economics of corruption, you'll find a lot to pick through at Jakob Svensson's home page . Svensson is with the Institute for International Economic Studies at Stockholm University.
He surveyed what we know about the links between corruption and growth in a 2005 paper, Eight Questions About Corruption (Journal of Economic Perspectives, 19(3):19-42 - one of the papers available on his homepage).
Theory generally suggests that corruption will slow economic growth. Corruption increases the costs of behaving in certain ways, and people will alter their behavior to avoid the cost:
In most theories that link corruption to slower economic growth, the corrupt action by itself does not impose the largest social cost. Instead, the primary social losses of corruption come from propping up of inefficient firms and the allocation of talent, technology and capital away from their socially most productive uses (Murphy, Shleifer and Vishny, 1991, 1993). When profits or potential profits are taken away from firms through corruption, entrepreneurs choose not to start firms or to expand less rapidly. Entrepreneurs may also choose to shift part or all of their savings toward the informal sector, or to organize production in a way that the need or demand for public services is minimized. Moreover, if entrepreneurs expect they will be forced to bargain over bribes in the future, they have incentives to adopt inefficient “fly-by-night” technologies of production with an inefficiently high degree of reversibility, which allows them to react more flexibly to future demands from corrupt officials—and more credibly threaten to shut down operations (Choi and Thum, 1998; Svensson, 2003).
Corruption also affects the allocation of entrepreneurial skills. When corruption is widespread and institutionalized, some firms may devote resources to obtaining valuable licenses and preferential market access, while others focus on improving productivity (Murphy, Shleifer and Vishny, 1991). In the extreme, it may be financially more rewarding for an entrepreneur to leave the private sector altogether and instead become a corrupt public official.
Some theorists think some types of corruption could be growth enhancing:
Corruption could conceivably have a positive effect on economic growth. The proponents of “efficient corruption” claim that bribery may allow firms to get things done in an economy plagued by bureaucratic hold-ups and bad, rigid laws (Leff, 1964; Huntington, 1968). A system built on bribery for allocating licenses and government contracts may lead to an outcome in which the most efficient firms will be able to afford to pay the highest bribes (Lui, 1985).
But he's not buying it:
However, these arguments typically take the distortions circumvented by the corrupt actions as given. In most cases, distortions and corruption are caused by, or are symptoms of, the same set of underlying factors. As Myrdal (1968) pointed out, corrupt officials may not circumvent distortions, but instead actually cause greater administrative delays to attract more bribes.
What does the evidence say? The evidence microeconomic evidence from studies of farmers, firms, and governments tends to support the theorists who argue that corruption slows down growth.
Bates (1981), for example, shows that in many sub-Saharan African countries, peasant farmers avoided corruption by taking refuge in subsistence production, with a consequent subsequent decline in productivity and living standards. Many formal sector firms, on the other hand, specialized in securing special advantages that they were unable to secure by competing in the marketplace. De Soto (1989) documents similar effects in Peru, where high start-up costs due to regulatory constraints and corruption forced entrepreneurs to establish new firms underground and on a smaller scale.
Does corruption affect firms’ choice of technology and the allocation of talent? Exploiting firm-level capital stock data on reported resale and replacement values, Svensson (2003) provides evidence suggesting that the amount of bribes a firm needs to pay is negatively correlated with the degree of reversibility of the capital stock—a result consistent with the “fly-by-night” hypothesis discussed above. Fisman’s (2001) findings on political connectedness in Indonesia suggest that some firms do specialize in corruption and rent seeking as means of growth and Khwaja and Mian’s (2004) results on borrowing and default rates of politically connected firms in Pakistan suggest that one of the reasons politicians start firms, or join existing ones, is that it enables them to capture public resources through corruption.
Specialization in corruption also occurs in the public sector. Wade’s (1982) vivid account of corruption in the canal irrigation department in a south Indian state describes how some irrigation engineers raise vast amounts in bribes from the distribution of water and contracts, and redistribute part to superior officers and politicians. The system of corruption is institutionalized, and there is even a second-hand market for posts that provide the holder an opportunity to extract bribes. Thus, politicians and senior officers are able to obtain for themselves part of the engineers’ income from corruption by auctioning available posts. Moreover, those specializing in corruption—and thereby able to earn many times their annual official income though bribes—will be able to outbid other contenders less able or less inclined to exploit their official powers to extract bribes. In this example, competition results in higher corruption.
Micro studies on corruption have also yielded insights about the long-run cost of corruption. Reinikka and Svensson (2005), building on the Ugandan newspaper campaign study by Reinikka and Svensson (2004b), find that the reduction in corruption caused by the information campaign had a significant and economically large effect on school enrollment and academic achievement. To the extent that human capital accumulation drives long-run growth, the results suggest an important mechanism through which corruption can hurt growth. Social service delivery in developing countries is often plagued by corruption of a variety of forms—bribes are charged for services to be provided and public funds are embezzled. Corruption is therefore a leading candidate to explain why the impact of public spending on growth and social welfare has been so disappointingly low in many countries.
Some suggestive evidence also exists on the relationship between corruption and growth at the firm level. Fisman and Svensson (2001) use firm-survey data on the estimated bribe payments of Ugandan firms to study the relationship between bribery payments, taxes and firm growth over the period 1995–1997. Using industry-location averages to circumvent the potential problem of endogeneity, they find that both the rate of taxation and bribery are negatively correlated with firm growth. For the full data set, a one percentage point increase in the bribery rate is associated with a reduction in firm growth of three percentage points, an effect that is about three times greater than that of taxation.
But the macroeconomic evidence is less clear. As this figure from the Economist article, The etiquette of bribery. How to Grease a Palm (Dec 19, 2006) shows, there is a correlation between corruption and income levels. The figure duplicates one from Svensson's article.
But he has trouble finding evidence of a relationship between corruption and growth:
What about the macro evidence? Mauro (1995) is the first attempt to study the relationship between corruption and growth in a large cross-section of countries. Contrary to what is sometimes claimed, Mauro does not find robust evidence of a link between corruption and growth, although a broader measure of bureaucratic efficiency is correlated with investment and growth. In Table 6, I updated Mauro’s calculations. I ran regressions with economic growth (over the period 1980–2000) as dependent variable and corruption (the International Country Risk Guide’s corruption indicator averaged over 1982–2000), initial GDP per capita and human capital as the explanatory variables. The estimated coefficient on corruption in this regression is negative—that is, less corruption is correlated with higher growth—but it is not significantly different from zero. I then added broad range of explanatory variables that have been suggested in the growth literature, but the coefficient on corruption remained insignificantly correlated with growth. Exploiting the panel dimension; that is, using five-year averages for corruption and growth and country-specific fixed effects to control for time-invariant country characteristics, also yields insignificant results.
This finding seems to lead to a puzzle. Most of the theoretical literature as well as case study and micro evidence suggest that corruption severely retards development. However, to the extent we can measure corruption in a cross-country setting, it does not affect growth. The puzzle may arise from econometric problems involved in estimating the effects of corruption on growth using cross-country data. For example, the difficulties of measuring corruption may include omitted variables, like the extent of market regulation, and reverse causality, like whether modernization and rapid growth may increase corruption, as Huntington (1968) argued. Another plausible explanation for the mismatch between the micro and macro evidence is that corruption takes many forms, and there is no reason to believe that all types of corruption are equally harmful for growth. Existing data, however, are by and large too coarse to examine different types of corruption in a cross-section of countries.