Simply defined, corruption is the misuse of public office for personal gain. In general, opportunities for corruption arise when the government size is large and its operations lack transparency, there is a plethora of regulations, and the rule of law is weak and natural resources constitute a large share of the country’s output. Corruption affects a country’s economic and social performance in various ways and erodes the public’s confidence in its institutions and policies.

The most notable impact of corruption is on a country’s growth and the resulting losses in per capita income, although a number of scholars have argued that a certain amount of corruption can “grease the wheels” of the economy by circumventing bureaucratic regulations. Notwithstanding these effects, there is overwhelming evidence that, overall, corruption lowers a country’s growth. Corruption is one of many factors—not the sole factor—that influences economic growth. The impact of corruption on growth varies across countries and depends on a host of factors.

The adverse impact on growth is felt through two channels. First, corruption increases the cost of investment for entrepreneurs who need to devote their scarce time and resources to fulfilling government regulations and bribing officials. This cost can be high for small and medium-sized enterprises (see Transparency International’s Business Principles for Small and Medium Enterprise).

Second, corruption acts as a barrier to foreign investment and results in the flight of capital out of a country. The use of public funds to acquire assets abroad shrinks the economy’s savings pool that could otherwise be used for investment. This has repercussions for future generations, particularly in resource-based economies; these generations may not be able to maintain the present level of consumption because of insufficient investment by the current generation. Studies indicate that corruption does not influence aid flows to countries that rely on them, although some donor agencies are increasingly using corruption as an indicator to guide their aid allocations.

Corruption affects the public finances of a country and reduces fiscal space for funding high-priority programs. First, it creates incentives for officials to shift budgetary allocations toward less-productive investments or military spending as well as lowers the efficiency with which public resources are used. In general, there is less transparency in government operations in the defense sector because of the secrecy surrounding these outlays (see Transparency International UK’s Defense Against Corruption Project). As the scope for rent seeking is relatively less in the education sector, budgetary allocations for this sector are smaller than the optimum.

The medium to long-term consequences of distorted budget allocations are felt in terms of smaller investment in human capital and a lower growth in labor productivity. Similarly, budgetary allocations for books, medicines, and maintenance of roads and other infrastructure tend to be lower. As a result, productivity of past investments in infrastructure and the quality of public services suffers. Second, fiscal space is influenced by the ability of the government to raise revenues in an efficient and equitable manner. When officials collude with citizens to reduce their tax liability, the revenue take of the government drops.

Corruption also makes the tax system regressive, as the poor do not gain by under-reporting their incomes, while the rich do, by conniving with tax officials. Corruption reduces the incentive to mobilise domestic revenues when a country receives a significant amount of foreign aid.

The adverse impact of corruption is not confined to public finances. Corruption has implications for social outcomes, such as a country’s child and infant mortality rates and dropout rates in primary schools. This is because corruption increases the cost of health care and education when population has to pay unofficial fees or illegal charges to obtain these services. As the poor tend to rely more on public services, higher user costs limit their access to government facilities. Corruption also reduces the volume of publicly provided services because of theft of medicines and books.

Studies indicate that a leakage of resources due to weak budget institutions and systems in many developing countries prevents resources from reaching the intended areas. In recent years, devolution of social spending to sub-national governments in these countries has increased, but the budget systems at lower levels of government are substantially weaker than at the federal level. Finally, corruption worsens the incidence of poverty and income distribution. This is because corruption lowers growth, biases tax systems, and results in poor targeting of social programs.

To sum up, reducing the incidence of corruption would require policymakers to act on many fronts, including reassessing the role of the government and regulations, enhancing transparency of government operations, and strengthening fiscal institutions and the rule of law. What the above analysis indicates is that it is an issue that they can little afford to ignore when working to make progress on the Millennium Development Goals and spreading the benefits of globalisation to their populations.

Dr. Sanjeev Gupta is Senior Advisor in the Fiscal Affairs Department of the International Monetary Fund (IMF). He was previously Assistant Director in the African Department and Chief in the Expenditure Policy Division of the Fiscal Affairs Department of the IMF. Prior to joining the IMF, he was a fellow of the Kiel Institute of World Economics, Germany; Senior Faculty in the Administrative Staff College of India; and Secretary of the Federation of Indian Chambers of Commerce and Industry, New Delhi. He has published extensively on macroeconomic and fiscal issues, particularly in developing countries and transition economies.