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How Does Corruption Affect Public Debt? An Empirical Analysis

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  • Cooray, Arusha
  • Dzhumashev, Ratbek
  • Schneider, Friedrich

Abstract

This paper investigates the relationship between corruption, the shadow economy, and public debt. It additionally examines whether the shadow economy increases the adverse effects of corruption on public debt. The model is empirically tested for 126 countries over 1996–2012. Using Ordinary Least Squares (OLS), Fixed effects, system generalized method of moments (GMM) and instrumental variable estimation, and two measures of corruption—the Transparency International Corruption Perceptions Index and the Kaufmann et al. Corruption Index—results confirm that increased corruption and a larger shadow economy lead to an increase in public debt. Results additionally indicate that the shadow economy magnifies the effect of corruption on public debt suggesting that they act as complements. Results also suggest that a larger shadow economy reduces tax revenues and thus increases public debt, similarly, higher government expenditure enhances the effects of corruption on government debt. Hence reducing corruption should be a primary policy goal of governments. Given the complementarity detected between corruption and the shadow economy, reducing corruption would also lead to a fall in the size of the shadow economy and public debt. Reducing corruption will also minimize the adverse effects of corruption on government debt through government expenditure.

Suggested Citation

  • Cooray, Arusha & Dzhumashev, Ratbek & Schneider, Friedrich, 2017. "How Does Corruption Affect Public Debt? An Empirical Analysis," World Development, Elsevier, vol. 90(C), pages 115-127.
  • Handle: RePEc:eee:wdevel:v:90:y:2017:i:c:p:115-127
    DOI: 10.1016/j.worlddev.2016.08.020
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    More about this item

    Keywords

    corruption; public debt; government expenditure; shadow economy;
    All these keywords.

    JEL classification:

    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law
    • O5 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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