Using panel data from 1996 to 2005, this paper shows that the effect of government size on corruption is positive at a low level of democracy, but it is negative at a high level. This finding could fill the gaps in previous studies whose findings on the relationship between corruption and government size are controversial.Corruption; Government size; Democracy; Panel data

Go, Kotera

Okada, Keisuke

Samreth, Sovannroeun

English

Research Papers in Economics

A panel study on the relationship between corruption
and government size
Go Kotera
Graduate School of Economics, Kyoto University, Japan
Keisuke Okada∗
Graduate School of Economics, Kyoto University, Japan
Sovannroeun Samreth
Japan Society for the Promotion of Science (JSPS)
Graduate School of Economics, Kyoto University, Japan
February 2010
Abstract
Using panel data from 1996 to 2005, this paper shows that the eﬀect of
government size on corruption is positive at a low level of democracy, but it
is negative at a high level. This ﬁnding could ﬁll the gaps in previous studies
whose ﬁndings on the relationship between corruption and government size
are controversial.
Keywords: Corruption; Government size; Democracy; Panel data
JEL Classiﬁcation: C23; D73; H11
1 Introduction
Corruption is a main factor that hinders economic growth, reduces government’s
legitimacy, and aﬀects political stability across time and countries (e.g., Mauro,
1995 and La Porta et al., 1999). For this reason, searching for a mechanism to
determine corruption has been conducted by many studies, including Treisman
(2000), Serra (2006), Billger and Goel (2009) and Saha et al. (2009). Some exam-
ine corruption by considering government size. La Porta et al. (1999) conclude
that a large government has lower corruption level due to stronger checks and bal-
ances. On the other hand, Rose-Ackerman (1999) argues that large government
∗Corresponding author: Graduate School of Economics, Kyoto University, Yoshida-
hommachi, Sakyo-ku, Kyoto, 606-8501, Japan. Email: keisuke.okada.1125@gmail.com.
1aﬀects bureaucracy eﬃciency and increases corruption. More recently, Billger and
Goel (2009) examine the sensitivity of determinants to the conditional distribu-
tion of corruption across countries. Although they show that larger government
generally decreases corruption, but in the most corrupt countries, the eﬀect is
insigniﬁcant.
As seen from the above studies, the results on the eﬀect of government size
on corruption are mixed. Based on the analysis of 140 countries’ panel data
from 1996 to 2005, this paper contributes to the literature about corruption by
providing a new empirical analysis on the relationship between government size
and corruption. We consider the eﬀect of the interaction between government
size and democracy, which has not been considered in previous studies to the
best of our knowledge. This approach is interesting because democracy is deemed
a factor that reﬂects government transparency or a kind of yardstick to explain
the eﬀect of government size on corruption. Since corruption is a severe problem
especially faced by developing countries, this study focuses on them. However,
we also provide the results of full countries sample for comparison.
2 Estimation Methodology and Data
To measure the eﬀect of government size on corruption based on the level of
democracy, the estimation equation is speciﬁed as below:
corruptioni,t = α0 + α1govsizei,t + α2democracyi,t (1)
+ α3govsizei,t × democracyi,t + X′
i,tΛ + εi,t,
where i and t are the country identity and the time series; govsize stands for
government size; X is a vector of the variables that may also inﬂuence the cor-
ruption; Λ is a coeﬃcient vector; ε is an error term. X includes the logarithms of
per capita GDP, the political stability, the economic freedom, the urbanization,
the regulatory quality and regional dummies.
From Eq. (1), the net eﬀect of government size on corruption can be calculated
as follows:
∆corruptioni,t
∆govsizei,t
= α1 + α3democracyi,t. (2)
From Eq. (2), the impact of government size on corruption is a function of the
level of democracy. As previously mentioned, this paper focuses on developing or
non-OECD countries. However, we also conduct the estimation for the case of
full counties for comparison.
As for the data, this study utilizes annual data spanning from 1996 to 2005
2in 140 countries, 110 of which are non-OECD and deﬁned as developing coun-
tries. The sample period and the numbers of countries are selected based on data
availability. The data deﬁnitions and sources are summarized in Table 1.
3 Empirical Results
Table 2 reports the estimation results in the developing countries. Columns (1),
(2) and (3) are the results of pooled ordinary least squares (OLS) estimation. In
column (1), the independent variables contain only government size, democracy
and their interaction term. The coeﬃcient of government size is insigniﬁcant. This
may be due to the problem of omitted variables. To avoid this problem, to column
(2) we add variables that may inﬂuence corruption, as indicated by many previous
studies. The negative eﬀects of income, political stability, economic freedom and
regulatory quality on corruption are consistent with such previous studies as La
Porta et al. (1999) and Treisman (2000). Column (3) shows the results when four
regional dummies are added simultaneously to control the time invariant regional
speciﬁc eﬀect.
Columns (4) and (5) report the results of ﬁxed eﬀects (FE) and random eﬀects
(RE) estimations. Based on the Hausman test, FE estimation is preferable to RE
estimation. Note that FE estimation can solve the endogeneity problems at some
level if they arise from the correlation between country speciﬁc and error terms.
Since FE estimation considers the country speciﬁc eﬀects, we can obtain the
unbiased coeﬃcients even if the unobserved country speciﬁc term is correlated with
the error term. Hence, this paper concentrates on FE estimation. Since income,
economic freedom and regulatory quality have negative eﬀects on corruption, it
is reasonable to judge that our FE estimation results are plausible.
Fig. 1 captures the eﬀect of government size on corruption with the level of
democracy based on the FE estimation results for developing countries. Although
the pooled OLS results indicate that this eﬀect is negative regardless of the level
of democracy, the FE estimation result suggests that it is positive at a low level
of democracy. One possible explanation is that, in less democratic countries,
the increase in government size may lead to more opportunities for rent seeking,
worsening the corruption level.
Additionally, for comparison, we also conduct estimation for the sample of
full countries. The results are presented in Table 3. Column (4) shows that
the coeﬃcients of income and economic freedom are not signiﬁcant in this case,
but they are signiﬁcant for developing countries. This result may reﬂect that
income and economic freedom are not the determinants of corruption in developed
countries where income is already high and economic freedom is secured to some
3extent. Fig. 2 provides the result of the partial eﬀects of government size on
corruption for full countries. Given Figs. 1 and 2, there is a possibility that
these eﬀects are undervalued, particularly for countries with a medium level of
democracy.
Our above results provide evidence that the impact of government size on cor-
ruption can be positive or negative depending on the country’s level of democracy.
This ﬁnding might help ﬁll the gap in the previous studies that ﬁnd controversial
results on the relationship between corruption and government size.
4 Conclusion
This paper empirically examines the relationship between government size and
corruption. Our estimation results suggest that the eﬀect of government size on
corruption is positive at a low level of democracy and negative at a high level of
democracy. This ﬁnding sheds light on how to explain the controversial ﬁndings of
previous studies on the relationship of corruption and government size. Although
panel estimation with instrumental variables is not considered in our estimation
methodology, the endogeneity problems are slightly improved by using ﬁxed eﬀects
(FE) estimation. Future work includes a more profound study using instrumental
variables.
Acknowledgements
The third author wishes to acknowledge the ﬁnancial support from the Japan
Society for the Promotion of Science (JSPS).
4References
Billger, S. M. and R. K. Goel, 2009, Do existing corruption levels matter in
controlling corruption? Journal of Development Economics 90, 299-305.
La Porta, R., F. Lopez-de-Solanes, A. Schleifer and R. Vishny, 1999, The quality
of Government, Journal of Law, Economics and Organization 15, 222-279.
Mauro, P., 1995, Corruption and growth, Quarterly Journal of Economics 110,
681-712.
Rose-Ackerman, S., 1999, Corruption and Government, Cambridge University
Press, Cambridge.
Saha, S., R. Gouder and J. Su, 2009, The interaction eﬀect of economic freedom
and democracy on corruption: a panel cross-country analysis, Economics
Letters 105, 173-176.
Serra, D., 2006, Empirical determinants of corruption: a sensitivity analysis,
Public Choice 126, 225-256.
Treisman, D., 2000, The causes of corruption: a cross-national study, Journal of
Public Economics 76, 399-457.
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6Table 2: Estimation results in developing countries
Dependent variable: Corruption
(1) (2) (3) (4) (5)
Government size -0.004 -0.011** -0.012*** 0.010** 0.008**
(0.006) (0.004) (0.004) (0.004) (0.004)
Democracy -0.080*** 0.081*** 0.056** -0.012 0.034
(0.028) (0.021) (0.022) (0.028) (0.023)
Government size democracy -0.002*** 0.000 -0.000 -0.001** -0.001***
(0.000) (0.000) (0.000) (0.000) (0.000)
GDP per capita (ln) -0.252*** -0.265*** -0.374* -0.460***
(0.058) (0.060) (0.217) (0.090)
Political stability -0.403*** -0.442*** 0.063 -0.136*
(0.060) (0.059) (0.084) (0.070)
Economic freedom -0.012* -0.006 -0.012* -0.012**
(0.007) (0.006) (0.006) (0.005)
Urbanization -0.002 -0.005** 0.028 -0.000
(0.002) (0.002) (0.017) (0.004)
Regulatory quality -1.030*** -1.003*** -0.280*** -0.460***
(0.123) (0.122) (0.108) (0.095)
Africa 0.158
(0.771)
Asia 0.239
(0.772)
Europe 1.028
(0.774)
Latin America 0.540
(0.772)
Constant 7.526*** 8.760*** 8.496*** 8.544*** 10.425***
(0.201) (0.562) (0.979) (1.354) (0.593)
Number of observations 686 500 500 500 500
R-squared 0.175 0.711 0.740 0.201 0.654
Notes:
1. The asterisks ***, ** and * are 1%, 5% and 10% of signiﬁcant levels.
2. The numbers in parentheses are standard errors.
7Table 3: Estimation results in full countries
Dependent variable: Corruption
(1) (2) (3) (4) (5)
Government size 0.010 0.000 0.003 0.009** 0.012***
(0.006) (0.005) (0.005) (0.004) (0.004)
Democracy -0.119*** 0.136*** 0.128*** -0.032 0.021
(0.027) (0.021) (0.021) (0.026) (0.022)
Government size democracy -0.004*** -0.001*** -0.002*** -0.000* -0.001***
(0.000) (0.000) (0.000) (0.000) (0.000)
GDP per capita (ln) -0.424*** -0.484*** -0.039 -0.673***
(0.058) (0.057) (0.206) (0.091)
Political stability -0.541*** -0.515*** 0.032 -0.165**
(0.068) (0.065) (0.075) (0.068)
Economic freedom -0.019** -0.010 -0.009 -0.010*
(0.007) (0.007) (0.005) (0.005)
Urbanization 0.000 -0.001 0.021 0.001
(0.002) (0.002) (0.016) (0.005)
Regulatory quality -1.028*** -0.994*** -0.310*** -0.473***
(0.133) (0.127) (0.094) (0.088)
Africa 1.099***
(0.267)
Asia 1.479***
(0.263)
Europe 1.953***
(0.250)
Latin America 1.725***
(0.263)
North America 0.713**
(0.340)
Constant 7.673*** 9.775*** 8.421*** 5.453*** 11.626***
(0.221) (0.607) (0.644) (1.378) (0.585)
Number of observations 998 707 707 707 707
R-squared 0.521 0.521 0.854 0.166 0.800
Notes:
1. The asterisks ***, ** and * are 1%, 5% and 10% of signiﬁcant levels.
2. The numbers in parentheses are standard errors.
8Figure 1: Partial eﬀects of government size on corruption in developing countries
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Figure 2: Partial eﬀects of government size on corruption in full countries
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9

A panel study on the relationship between corruption and government size

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