Corruption and Investment Choices: A Panel Data Study

There is evidence in the literature that corruption lowers the level of investment and the productivity of capital stock in an economy. This paper extends the literature by presenting evidence that investment allocation decisions are affected in a significant way by corruption. The most commonly used measure of the efficiency of overall investment in an economy is the incremental capital output ratio (ICOR), measured by the ratio of gross investment to the change in the gross domestic product. The inverse of the ICOR measures the productivity of investment in an economy. When the known explanatory factors for inter-country variation in the ICOR are taken into account, the incidence of corruption has a statistically significant negative effect on the efficiency of investment for a panel of 90-140 countries during 1995-2004. The strength of this effect increases with the incidence of corruption. The econometric model used is robust to unobserved and time-invariant country fixed effects, feedbacks from current stochastic shocks to subsequent values of the determinants of investment efficiency, and the persistence of efficiency. Copyright 2007 Blackwell Publishing Ltd..