Policy Compromises: Corruption and Regulation in a Democracy

Abstract

This paper evaluates the extent of regulation in a democracy with corruption. Elected politicians can restrict entry of firms in exchange for bribes from entrepreneurs. Full liberalization implies free entry and allocative efficiency. Voters reelect politicians based on observed performance. We demonstrate that voters agree to tolerate corruption and inefficient regulation; that efficient policies can be promoted by productivity growth; that productivity growth reduces the cost of providing wage incentives; and that economic policy is counter-cyclical in a corrupt democracy.

Keywords: Corruption, entry regulation, performance voting, economic growth

JEL Classification: D72, K42, O41