An Empirical Analysis Of The Relationship Between Corruption And Inflation

Author

Hussein Elkamel, Southern Illinois University CarbondaleFollow

Date of Award

5-1-2014

Degree Name

Doctor of Philosophy

Department

Economics

First Advisor

Morshed, AKM

Abstract

This dissertation is a collection of three chapters on the effect of corruption on inflation through public finance channels. Those chapters test the following hypothesis corrupt officials such as tax collectors, procurement officials, government sales officials, and so on, waste liquid government resources through their corrupt practices. The waste of resources by corrupt officials at multiple levels of a government may cause budget deficits or at least create a need for liquidities. Therefore, a government will evaluate its available options to meet this need and make a decision taking into consideration one or a combination of options. Such a decision is unavoidable. The first attempt at a solution may take the form of seigniorage, followed by borrowing. Financing this need will result in expansionary budget spending, thus leading to higher inflation. Chapter 1 tests the effects of corruption on inflation through public finance channels, seigniorage and debt financing. We use data for 1995 2011 across 72 countries, and apply techniques that control for the possible endogeneity. In all of our various models the estimated specifications show that corruption contributes to inflation both on its own and through public finance channels. The results are significant and have the right sign, which gives evidence of the contribution made by corrupt officials to increasing inflation, thus eventually hurting growth. The positive and significant results linking debt financing with corruption indicate that corrupt officials have alternative sources of funds when seigniorage is restricted. For policy makers, bringing about a diminishment in the effects of corruption on inflation requires a parallel strategy involving both central bank independence and government borrowing. In Chapter 2 we have investigated the relationship between corruption and inflation for all US states by examining the misuse of federal transfers to states as a channel. Our state level corruption measure consists of the number of officials convicted. We use data for the period of from 1992 through 2007 with different model specifications, fixed effect and second stage least square models. We find that state corruption contributes to higher levels of inflation. This result is robust throughout our differing model specifications. The effect of corruption on inflation takes place indirectly through state public financing, specifically federal transfer. In addition, our results are also robust when scaling convicted officials to size of state population, number of state prisoners, and number of state public employees. Chapter 3 tests our hypothesis using a developing country over regional level, Indian states. We use corruption data on perception and experience that Below Poverty Line households encounter when obtaining public services. We assume that corruption across Indian states hurts people who live below the poverty line. These people are already hurt by their poverty, which causes state governments to spend more to provide them aid and which also prevents such households from effectively participating in the state's economic growth. These high levels of state spending and lower growth rates have inflationary consequences. We found no direct relationship between corruption and inflation, indicating in agreement with the literature on corruption that the impact of corruption on inflation through certain channels is indirect, through public finance channel. We conclude that Indian state governments suffer from corruption that causes the "common man" to pay bribes in exchange for public services. This causes more households to claim more aid from their state governments, also prevents those households from effectively participating in their state's economic growth. Thereby, the rate of inflation increases along with this expansionary state spending.