The hidden impact of corruption

Abstract

Many economic studies on corruption are dealing with their actual occurrence. This paper claims., on the other hand, that important economic effects arise even when corruption does not actually take place but remains a serious threat. Although corruption can be prevented through intensive monitoring and surveillance or by offering effective disincentives, these measures are costly and create distortions – a situation that may be described as “hidden corruption”. This paper formalizes corruption as a special principal-agent-client relation. It identifies some fundamental economic characteristics of corruption and distinguishes three different types of equilibria that arise under different circumstances. Whereas corruption actually occurs in only one of these equilibria, some key effects persist, although reduced in magnitude, in the other two types. Significant differences occur instead when the possibility of corruption is removed. The paper addresses other topics related to corruption as well, such as why corruption is illegal, its effects on efficacy and distribution, and the possibility and implications of multiple equilibria.