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Are Financial Development and Corruption Control Substitutes in Promoting Growth?

Christian Ahlin and Jiaren Pang ()

No 709, Vanderbilt University Department of Economics Working Papers from Vanderbilt University Department of Economics

Abstract: While financial development and corruption control have been studied extensively, their interaction has not. We develop a simple model in which low corruption and financial development both facilitate the undertaking of productive projects, but act as substitutes in doing so. The substitutability arises because corruption raises the need for liquidity and thus makes financial improvements more potent; conversely, financial underdevelopment makes increased corruption more onerous and thus raises the gains from reducing it. We test this substitutability by predicting growth, of countries and industries, using measures of financial development, lack of corruption, and a key interaction term. Both approaches point to positive effects from improving either factor, as well as to a substitutability between them. The growth gain associated with moving from the 25th to the 75th percentile in one factor is 0.63-1.68 percentage points higher if the second factor is at the 25th percentile rather than the 75th. The results show robustness to different measures of corruption and financial development and do not appear to be driven by outliers, omitted variables, or other theories of growth and convergence.

Keywords: Financial development; growth; complementarity; corruption (search for similar items in EconPapers)
JEL-codes: O16 O17 O40 O43 (search for similar items in EconPapers)
Date: 2006-12
New Economics Papers: this item is included in nep-dev, nep-pol, nep-ppm and nep-reg
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http://www.accessecon.com/pubs/VUECON/vu07-w09.pdf Revised version, 2007 (application/pdf)

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Journal Article: Are financial development and corruption control substitutes in promoting growth? (2008) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:van:wpaper:0709

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