Combating Corruption: On the Interplay between Institutional Quality and Social Trust

Abstract

The aim of this paper is to explore under which conditions institutional quality leads to lower corruption. A model of a simple economy where firms both chose between bribing or not bribing bureaucrats to avoid costs and between entering the official or unofficial economy shows that the effects of increasing institutional quality may be ambiguous due to perverse effects of institutions in the unofficial economy. Employing a recent index of corruption based on objective data, the paper shows that formal institutions are more effective in combating corruption in countries with high levels of social trust. The paper concludes by discussing the welfare and political implications of the findings.

Keywords: Corruption, Rent-seeking, Social trust

JEL Classification: D72, K42, Z13