A General Equilibrium Model of Corruption

This paper develops a General Equilibrium model to quantify the economic cost of corruption by incorporating it as a distinct activity within a closed economy. Unlike traditional approaches that treat corruption as an exogenous friction, our model endogenizes the choice between productive labor and rent-seeking activities. Specifically, we introduce an auxiliary technology that captures the role of corruption in diverting labor away from the formal sector and distorting resource allocation, thereby reducing overall economic output. Our findings reveal that corruption can reduce the steady-state output by over 4%, highlighting its significant impact on economic welfare. The model also suggests that policies such as reduced labor taxes or improved oversight could mitigate these losses by discouraging the shift of labor into unproductive corruption activities. This framework offers a new perspective on the costs of corruption and serves as a tool for policymakers to evaluate interventions that could enhance productivity by curbing rent-seeking incentives.