Sci.Int.(Lahore),33(1),59-62,2021 ISSN 1013-5316; CODEN: SINTE 8 59
March-April
IS CORRUPTION SAND OR GREASE IN THE WHEELS OF INVESTMENT?
*Imran Ali, Saidatulakmal Mohd
School of Social sciences, Universiti Sains Malaysia
*Corresponding author E-mail: imranalimoroojo@gmail.com
ABSTRACT: This study is an attempt to explore the direct and indirect impact of corruption on private investment. For
indirect impact, governance quality has been used as a transmission channel for the sample of six Asian (developing) countries
namely Bangladesh, India, Maldives, Nepal, Pakistan, and Sri-Lanka, covering the period 1996-2017. This study has used
cross-section and panel data estimation (Fixed Effects). The results confirmed that corruption hurts private investment directly
as well as indirectly. While combating corruption is a long-term challenge and a transmission channel through which
corruption affects private investment is another way to restrict the adverse impact of corruption. Based on estimation results,
this study provides a policy suggestion to these six Asia countries, that improves the quality of governance which will limit the
adverse impact of corruption and will encourage private investment.
Key Words: Corruption, governance quality, direct and indirect effect, transmission channel.
1. INTRODUCTION
It is a common consensus among economists that long-run
growth a result of capital accumulation. However, there is
still a gap in the knowledge to explore the factors which in
turn determine the rate of physical capital. Secondly, growth
economists are not on the same page to understand the
relationship between the quality of institutions and physical
capital [1]. This study is an attempt to explore that are weak
government institutions are the product of corruption and
secondly what is the impact of those government institutions
on physical capital?
Before going into deep analysis, it is necessary to know what
corruption is? But defining corruption is no an easy task
because it ranges from broad terms of "misuse of power" to
the strict most common definition as an act of bribery having
the involvement of public officer [2]. It is an illegal and
immoral action which normally practiced secretly [3]. In the
past corruption has been studied as a problem of cultural and
moral underdevelopment. But it has received special attention
when International Transparency defines corruption as
"misuse of public offices for private benefits".
Nowadays, economists, historians, and political scientists are
actively engaged in exploring more about corruption, and its
impact on different economic indicators. Theoretically as
well as empirically scholars are not on the same page because
some scholars are in favor of corruption [4, 5, 6] and some
are against it [1, 3, 7, 8]. Such as, Corruption discourages
private investment by raising hidden costs of production and
by raising uncertainty over future returns from a current
investment [9]. Similarly, it hurts good governance [10].
Because those countries which are experiencing bad
governance, are facing a high level of corruption [11].
Hence, the main objective of this research is to find the
impact of corruption on private investment through
government intervention as a transmission channel in six
Asian economies (SAARC countries) namely Bangladesh,
India, Maldives, Nepal, Pakistan, and Sri Lanka.
2. LITERATURE REVIEW
When there is a theoretical concern, Domar [12] and Harrod
[13] are among the pioneer contributors who stressed the
importance of physical capital for the overall welfare of the
economy. They independently constructed a model (Harrod-
Domar Model) in which they stressed saving and investment,
which ultimately leads to a higher growth rate. Solow-Swan
Growth model [14,15] also an emphasis on capital
accumulation including population growth. Therefore, this
study is an attempt to explore whether corruption is a curse
for investment or it is a blessing.
Nowadays, it is confessed by most empirical studies that
corruption hurts private investment. But some researchers [4,
5, 6] have addressed that corruption may encourage private
investment. Because bribes can help in avoiding bureaucratic
regulations and it serves as an incentive for government
officials to accelerate their duties.
On the other hand, Mauro tried to explore the relationship
between corruption and private investment for 58 countries,
having data from 1970 to 1985. He confirmed that corruption
has a statistically significant adverse impact on private
investment which in turn affect negatively on the overall
economy [1].
Corruption hurts capital accumulation and innovation because
innovators somehow need government support, for instance,
infrastructure, permits, and import quotas. On the other hand,
the demand for those goods is high and inelastic, which
becomes a primary cause of corruption. Secondly, producers
(innovators) have credit-constrained to pay bribes, which
ultimately reduce private investment [3]. Later on, various
studies have recheck these results and they confirmed that as
the level of corruption is increasing private investment is
significantly decreasing [8, 16, 17].
Similarly, many studies have confirmed that corrupt
government institutions cause a severe obstacle for
investment and innovation. Such as violation of property
rights over physical capital may cut incentives and
opportunities to invest in physical capital. Government
officials may create hurdles in providing licenses and
permits, which ultimately slows down the process of
innovation and new processes of production [18, 19].
Furthermore, it also been found by using panel data of 46
developing countries, with the period of 1996-2009. They
tried to investigate the impact of good governance on private
investment. Outcomes identified that a high level of
corruption and political instability are indicators of bad
governance. Furthermore, estimated concluded that bad
governance has a statistically significant adverse impact on
overall private investment and vice versa [20]. Similarly,
these also have been confirmed these results by using the data
of North Africa and the Middle East region to address the
problems of private investment is confirmed and it has been
confirmed that higher private investment is a byproduct of
good governance [21].
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Moreover, Emery took African countries and did cross-
country analysis, in which he found that quality of
governance has a strong influence on the level and nature of
private investment. Even though private investment is a
major determinant of economic growth which in turn helps
alleviate poverty and improve the living standard of citizens.
But unfortunately, most of the countries in Africa are unable
to create an investment-friendly atmosphere because of their
low quality of governance [22].
3. DATA AND METHODOLOGY
3.1 Data and sources
Nowadays, it has been admitted in the empirical studies to
include institutions as an ordinary explanatory variable in the
regressions related to growth. This study is following the
World Governance Index to measure the level of corruption
and quality of governance. Furthermore, controlling variables
of corruption are followed by growth literature [7, 17, 23]
which are possibly linked with corruption namely foreign
direct investment, population, political stability. Table .1
shows a list of all variables and their sources.
Table .1: Variables their definition and source
Variables
Definitions
Sources
Private
Investment
Capital stock in trillions
(USD)
Penn World
Table 9.1
Corruption
Index
Perception of public power
used in private gain (petty as
well as grand forms)
World
Governance
Index
Governance
quality
Perception of quality of
public, civil service and its
independence from political
pressures
World
Governance
Index
Foreign
investment
It’s a net inflow of
investment from other
countries (in USD)
World Bank
Dataset
Population
Population (in millions)
Penn World
Table 9.1
Political
Stability
Perception of the possibility
that the government will be
destabilized/overthrown.
The Global
Economy
Source: Constructed by authors.
3.2 Methodology
The main objective of this study is to find the direct, indirect,
and total impact of corruption on private investment for a
sample of 6 Asian (developing) countries for 1996-2017. This
study is using methodology to find the indirect impact of
corruption on economic growth through various transmission
channels which is commonly used in the literature [3, 7, 17].
However, this study is using governance quality as a
transmission channel and its impact on private investment.
This study will apply the ordinary least squares (OLS)
method on the following equations and panel data estimation
(fixed effect) techniques.
By substituting equations (2) in (1) and we will get equation
(3)
Now by taking the partial derivative of concerning
we will get equation (4)
=
1+
21 (4
)
1
is the direct effect of corruption and
21
is the indirect
effect of corruption on private investment through
1+
21
is the total impact of corruption on private
investment.
4. ESTIMATED RESULTS
Table.2 is the estimation result of equations(1) and (2).
Regression (1) presents the impact of corruption on private
investment including, governance quality, controlling
variables namely foreign direct investment, total population,
and political stability. All the coefficients of explanatory
variables have predicted sign statistically significant results.
The R2 is 0.92, meaning that 9percentnt variation in private
investment can be caused by all independent variables. The
coefficient of corruption shows a positive sign but it reflects
the negative influence on private investment with statistically
significant at 10 percent (P-value). Corruption
Table.2: Ordinary Least Squared (OLS) results of equation (1)
and (2)
VARIABLES
Private
Investment
Governance
Quality
Corruption
0.446*
0.758***
(0.334)
(0.239)
(0.0781)
Foreign Investment
0.511***
(9.823)
(0.0742)
Governance
Quality
-0.755**
(0.394)
(0.329)
Total Population
0.00369***
0.000119*
(417.31)
(0.000825)
(6.24e-05)
Political Stability
0.276**
(0.922)
(0.114)
Constant
0.105
0.0858
(0.126)
(0.0610)
Observations
132
132
R-squared
0.923
0.465
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
the index varies from -2.5 to 2.5, and a higher value reflects
low corruption and vice versa. Hence corruption has a
significant impact on private investment, a decline in
corruption of one standard deviation increases privative
investment by 148.9 billion USD. Similarly, an increase in
the foreign direct investment of one standard deviation
increases private investment by 5 trillion USD. In this model,
a decrease in the governance quality of one standard
deviation leads tan o increase in private investment by 297
billion USD. On the other hand and, an increase in the total
population of one standard an leads in to increase private
investment by 1.53 trillion USD. Similarly, an increase in the
political stability of the one standard deviation increases
private investment by 254 billion US Dollars.
The second column shows regression (2), which is the result
of equation (2) where governance quality is the dependent
variable and corruption and population are the independent
variables. Both coefficients of explanatory variables have
predicted sign significant results. The R2 is 0.46, meaning that
46.5 percent variation in governance quality can be caused by
corruption and population. The coefficient of corruption
Sci.Int.(Lahore),33(1),59-62,2021 ISSN 1013-5316; CODEN: SINTE 8 61
March-April
shows a positive sign but it reflects the negative influence on
private investment with statistically significant at 1 percent
(P-value). Hence corruption has a significant impact on
private investment, a decline in corruption of one standard
deviation increases privative investment by 253 billion USD.
Similarly, an increase in the total population of one standard
leads to an increase in private investment by 49.6 billion
USD.
Table.3 shows the estimated value of equation (4), which
depicts the direct, indirect, and total effect of corruption on
private investment. is the coefficient of corruption (as in
equation (1)) which shows the direct adverse impact of
corruption on private investment. But its sign is positive,
which is because the World Governance index of corruption
higher the value low the corruption. So, a one-unit decrease
in corruption will increase private investment by 44 percent.
The second column presents the indirect impact of corruption
on investment through governance quality transmission
channels. It shows a negative impact, and the column is the
overall impact of corruption on private investment which is
the sum of direct and indirect impact.
Table.3: Direct, indirect, and total effect of corruption on
Private Investment (OLS results)
Direct Effect
Indirect Effect
Total Effect
0.44
-0.74*0.75= -0.56
0.44 + 0.56 = -1.0
Source: Constructed by authors.
Table .4: Tests of endogeneity
Ho:
variables are exogenous
Equation (1)
Durbin (score) chi2(1)
= .303331 (p = 0.5818)
Wu-Hausman F(1,125)
= .287907 (p = 0.5925)
Equation (2)
Durbin (score) chi2(1)
= 1.09961 (p = 0.2944)
Wu-Hausman F(1,128)
= 1.07525 (p = 0.3017)
Source: Output of Stata software.
For handling the problem of endogeneity, two variables have
been used in the literature, as an instrumental variable of
corruption namely ethnolinguistic fractionalization [1] and
legal origins [8, 17]. This study has used legal origins as an
instrument for corruption and has applied two endogeneity
tests (Wu-Hausman and Durbin), and the null hypothesis of
both tests has been accepted in both regression equations,
meaning that variables are exogenous as stated in table.4.This
study is using panel data for six Asian countries, for 1996-
2017, to see whether there is the existence of heterogeneity
among these four countries. Hence F-test and Breusch Pagan
Lagrange Multiplier test has been used to select an
appropriate model both tests confirmed that the Fixed Effects
(FE) model (by F-Test) and Random Effects (RE) model (by
Breusch Pagan Lagrange Multiplier) are appropriate. To
select one between them Hauman test has been used which
suggested that the Fixed Effects model, which is displayed in
table.5.
Table.5: Direct, indirect, and total effect of corruption on
Private Investment (FE results)
VARIABLES
Private
Investment
Government
Quality
Corruption
0.144*
0.524***
(0.705)
(0.117)
Foreign Investment
0.111***
(0.0342)
Government Quality
-0.228
(0.567)
Total Population
0.0698***
(0.00487)
0.000110
(0.000399)
Political Stability
0.693***
(0.222)
Constant
-14.79***
-0.0612
(1.170)
(0.126)
Observations
132
132
R-squared
0.921
0.141
Number of countries
6
6
Standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
Table.6: Direct, indirect, and total effect of corruption on
Private Investment (FE results).
Direct Effect
Indirect Effect
Total Effect
0.14
0.52*0.23 = 0.12
0.14 + 0.12 = 0.26
Source: Constructed by authors
5. CONCLUSIONS
In recent empirical literature has explored the impact of
corruption on economic growth through various transmission
channels [3, 7, 16, 17] This study has used the same method
to find the direct and indirect impact of corruption on private
investment, for indirect impact governance quality has been
used as a transmission channel. Corruption is a broader
concept, and it has an existence in every sector of the
economy. Secondly controlling overall corruption is not an
easy task because of its nature [17]. The reason behind
finding the indirect effect of corruption on private investment
through governance quality was to find an alternative way to
stop the adverse impact of corruption on private investment.
The results of this study have confirmed a negative impact of
corruption on private investment which is accepted by most
of the empirical literature. Secondly, this study also
concludes that as corruption is increasing in six Asian
countries, the quality of governance is decreasing. And that
low governance quality ultimately hurts private investment.
Based on the outcomes of this study FDI has a positive
influence on private investment, meaning that FDI is creating
a spillover effect. Furthermore, political stability and
population growth are also encouraging private investment.
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