Are Financial Development and Corruption Control Substitutes in Promoting Growth?

Posted: 21 Feb 2009

See all articles by Christian Ahlin

Christian Ahlin

Vanderbilt University - College of Arts and Science - Department of Economics

Jiaren Pang

Tsinghua University - School of Economics & Management

Date Written: June 1, 2008

Abstract

While financial development and corruption control have been studied extensively, their interaction has not. We develop a simple model in which low corruption and financial development both facilitate the undertaking of productive projects, but act as substitutes in doing so. The substitutability arises because corruption raises the need for liquidity and thus makes financial improvements more potent; conversely, financial underdevelopment makes increased corruption more onerous and thus raises the gains from reducing it. We test this substitutability by predicting growth, of countries and industries, using measures of financial development, lack of corruption, and a key interaction term. Both approaches point to positive effects from improving either factor, as well as to a substitutability between them. The growth gain associated with moving from the 25th to the 75th percentile in one factor is 0.63-1.68 percentage points higher if the second factor is at the 25th percentile rather than the 75th. The results show robustness to different measures of corruption and financial development and do not appear to be driven by outliers, omitted variables, or other theories of growth and convergence.

Keywords: Financial Development, Growth Complementarity, Corruption

Suggested Citation

Ahlin, Christian and Pang, Jiaren, Are Financial Development and Corruption Control Substitutes in Promoting Growth? (June 1, 2008). Journal of Development Economics, Vol. 86, No. 2, 2008. Available at SSRN: https://ssrn.com/abstract=1340290

Christian Ahlin

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States
(615) 322-2482 (Phone)
(615) 343-8495 (Fax)

HOME PAGE: http://people.vanderbilt.edu/~c.ahlin/cv.pdf

Jiaren Pang (Contact Author)

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

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