Steven P. Lanza

English

Research Papers in Economics

 
 
 
The Economics of Ethics: The Cost of Political Corruption 
 
 
 
By: 
 
Steven P. Lanza, Executive Editor 
The Connecticut Economy Quarterly 
 
 
Reprinted from the Winter 2004 Issue: 
February 24, 2004 
 
 
 
 
 
 
 
 
 
 
CONNECTICUT CENTER FOR ECONOMIC ANALYSIS
 
Fred V. Carstensen, Director 
William F. Lott, Director of Research 
University of Connecticut 
341 Mansfield Road 
Unit 1240 
Storrs, CT 06269 
Voice: 860-486-0485 Fax: 860-486-0204 
http://ccea.uconn.edu 
 
1 
Adam Smith, a patriarch of economics and author of its bible, The Wealth of Nations, 
expressed what has become a credo of free market faith: the public interest is often best 
served by allowing individuals to pursue their own self interests.  Lately it seems some 
Connecticut politicians have been following Smith’s doctrine to a fault.  But the 
consequences are unlikely to have advanced the common interests of Connecticut’s 
citizens.  Indeed, the evidence suggests that the moral failings of political leaders carry 
significant economic costs. 
 
Political Corruption 
  Public officials are supposed to be trustees of the commonweal, not political 
buccaneers seeking their own private gain.  But sometimes, in what economists call a 
“principal-agent problem,” those trustees forsake that obligation and misuse the power 
delegated to them in ways that advance their personal interests rather than those of the 
public. 
The problem isn’t just limited to chief executives—mayors, governors and presidents—
accepting gifts or kickbacks.  Legislators, too, can sell their votes to special interests in 
exchange for campaign contributions or other special favors.  All such practices are 
morally reprehensible, often illegal, and they erode the public’s faith in political 
institutions.  But what are the economic consequences? 
 
Grease or Grime? 
  Not everyone agrees that even a little graft is a bad thing.  In the 1970s, political 
scientist Samuel P. Huntington wrote that “...in terms of economic growth, the only thing 
worse than a society with a rigid, over-centralized, dishonest bureaucracy is one with a 
rigid, over-centralized and honest bureaucracy.”  (See Political Order in Changing 
Societies, New Haven: Yale University Press, 1968: p. 69).  In this view, political bribes 
and kickbacks can help cut through bureaucratic red tape and improve government 
efficiency.  What’s more, if the size of the bribe reflects the value of the “favor” to the 
briber, government’s attention will naturally turn first toward those projects with the 
greatest net benefits.  Those net benefits, of course, may accrue to a select few rather than 
the general public.  
2 
  But the costs of corruption can be significant.  First, political corruption increases 
the cost of doing business by at least the amount of the bribe paid to secure favorable 
treatment.  Institutionalized bribery also introduces a new set of transaction costs—the 
costs of negotiating, monitoring and enforcing illicit agreements and avoiding detection 
by those not a party to the agreement.  And since corruption involves the arbitrary use of 
discretionary power, uncertainty—that great bogeyman of business confidence—rises, 
and the business environment becomes less secure. 
  Second, political corruption undercuts free markets and hampers efficiency.  
Firms with political connections can be less cost-conscious since they are shielded from 
competition.  Third, corruption distorts the allocation of resources toward projects that 
can generate (illicit) payoffs.  Besides the undesirable efficiency consequences arising 
from this distortion, the effect is likely to aggravate social inequalities, because the poor 
and powerless suffer, by definition, a comparative disadvantage in securing special 
favors.    
3 
 
 
Quantifying the Evidence 
  If an economic case can be made both for and against political graft, the relative 
efficiency of corruption ultimately becomes an empirical issue. Which economies 
demonstrate the best economic performance, those with a track record of clean 
government or those with a history of dirty political dealings? 
  While there is no single all-purpose measure of economic performance, when it 
comes to gauging the health of a local or regional economy job growth is often a popular 
02468 1 0 1 2
Vermont
New Hampshire
Nebraska
North Dakota
Kansas
Oregon
Iowa
Minnesota
Wisconsin
South Dakota
Idaho
Utah
Arkansas
Washington
Oklahoma
Maine
Montana
Colorado
Wyoming
Missouri
Connecticut
Michigan
Massachusetts
Delaware
Texas
Indiana
Nevada
Pennsylvania
Alaska
New Jersey
New Mexico
Kentucky
Illinois
Ohio
North Carolina
West Virginia
Alabama
Arizona
Rhode Island
New York
Mississippi
Tennessee
South Carolina
California
Louisiana
Georgia
Maryland
Florida
Virginia
How States
Rank in
Political
Corruption
Federal misconduct convictions per 100 elected officals, 1986-95 
Source: The Connecticut Economy based on data from Thomas Schlesinger and Kenneth J. Meier, "The Targeting 
of Political Corruption in the United States," in Arnold Heidenheimer and Michael Johnston, Political Corruption, 
3rd ed. (New Brunswick, NJ: Transaction Publishers), 2002, pp.627-644. 
4 
choice.  Maximizing an economy’s ability to generate new jobs is certainly high on the 
political agenda since voters seem more likely to re-elect officeholders who oversee net 
job creation. 
  Quantifying political corruption is, however, difficult partly because the 
perpetrators work so hard to evade detection.  But Thomas Schlesinger and Kenneth 
Meier have argued that the number of federal convictions of public officials for crimes 
involving corruption is a good proxy for the level of political corruption across states.  
The accompanying bar graph presents Schlesinger and Meier’s state-by-state conviction 
data for the period 1986 – 1996, for 49 states (omitting Hawaii).  The average across 
states was 2.12 convictions per 100 elected officials over the period.  Connecticut posted 
a comparatively clean record of just 1.08 convictions.   
  Among the advantages these analysts claim for this measure is that it passes the 
smell test: Vermont, Minnesota, and Wisconsin place relatively low on the list while 
Maryland, Louisiana and Rhode Island rank relatively high.  Plus, the measure appears to 
be statistically unrelated to the number of federal prosecutors and judges or the length of 
court backlogs. So high conviction rates are more likely to reflect corrupt activity than 
prosecutorial zeal. 
  If corruption was the only determinant of economic performance, we could 
compare the two and see how variations in the number of convictions affected the change 
in jobs.  But there are many other possible influences on job growth, such as taxes, 
wages, education, GSP per capita and population change.  So to determine the effect of 
corruption on performance, we must control for the influence of these other factors, 
something that multivariate regression allows us to do. 
 
Crime Doesn’t Pay 
  The accompanying table shows the results of a regression of job changes on 
corruption and these other possible causal factors.  As expected, there is an inverse and 
statistically significant relationship between corruption and jobs.  For each additional 
conviction per 100 elected officials, job growth declines by 1.1 percentage points (the 49-
state average was a 22% increase in jobs over the 1986-95 period).  A $100 increase in 
per-capita state taxes cuts job growth by 0.5 percentage points.  And by expanding the  
5 
pool of potential workers, a one-percentage point increase in population produces a 0.8-
point increase in the number of new jobs. 
  The remaining variables—wages, education, and per-capita GSP—had some 
surprising effects on job growth.  Higher wages are not associated with a significant 
decrease in jobs and increases in educational attainment are not linked to a significant 
increase in jobs.  Higher GSP per worker, which would seem to produce a stronger 
market for goods and services, turns out to be associated with reduced job growth, 
perhaps because high income areas often have higher rents and tighter regulations on 
business. 
  Since each of these explanatory variables is measured in different units, it could 
be difficult to determine which has the strongest influence on changes in job growth.  But 
a simple statistical technique allows us to express each variable in a common unit so that 
the resulting standardized coefficients, shown in the table, measure the relative 
magnitude of the effects from each.  These standardized coefficients suggest that 
population growth is as strong a positive influence on jobs as is the total negative 
influence from taxes, GSP and corruption combined.  That’s not to say corruption is a 
trifling matter.  Among the negative factors in job growth, the effect of corruption was 
30% greater than that of taxes, implying that honest government may be even more 
important than a favorable tax environment in sustaining strong economic performance. 
 
Airing the Linen 
  To his credit, Adam Smith was not a slavish disciple of his own teachings.  In an 
often overlooked volume, The Theory of the Moral Sentiments, Smith maintained that a 
peaceable and productive life in civil society isn’t possible without moral constraints that 
place socially appropriate limits on individual action.  Smith realized that the law, too, 
constrains our actions in ways that help to make markets and other social institutions 
work. 
  The question for Connecticut now is how to best improve the ethical and legal 
environment and avoid a repeat of recent scandals.  The suggestions include tougher 
restrictions on, and penalties for, giving gifts to elected officials, and extending the 
statute of limitations on criminal violations.  Here’s another possibility.  
6 
  If the problem actually is of the “principal-agent” variety, with elected officials 
secretly pursuing their own interests not those of their constituents, we might try bringing 
these activities into the open, letting the public be the arbiter of what’s acceptable 
conduct.  Requiring elected officials to make their personal finances public, for example, 
would offer voters an early warning sign of potentially unethical or criminal behavior.  
Toughening the ethics laws would no doubt help, but it’s likely that wayward public 
officials would be penalized by public disapproval far sooner and more effectively under 
a regime of full disclosure than under a system that relies on investigators to uncover 
misconduct and on prosecutors to enforce the law.   
 
 
 
    Variable
  Corruption
     
      Taxes
  
   Education
    
     Wages
  
  Population
Per Capita GSP
-0.20
-0.15
 0.02
-0.05
 0.79
-0.38
                                                       Description       
 One additional conviction per 100 elected officials reduces job growth by 1.1 percentage points.       
 A $100 increase in per-capita state taxes cuts job growth by 0.5 percentage points.       
 An increase in education produces no statistically significant increase in jobs.       
 An increase in wages produces no statistically significant decrease in jobs.       
 A one-percentage point increase in population produces a 0.8 percentage point increase in jobs       
 A $1000 increase in per-capita GSP lowers job growth by 1.0 percentage point.       
Standardized
  Coefficient
Factors That Explain Job Growth Across States
Source: The Connecticut Economy based on data from Schlesinger and Meier,and from the U.S. Bureaus of Labor Statistics, Census, and Economic Analysis.

The Economics of Ethics: The Cost of Political Corruption

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The Economics of Ethics: The Cost of Political Corruption

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