During America’s Gilded Age, corrupt politicians took bribes from powerful industrial conglomerates in deals that warped public policy and hurt the economy. Taxpayers lost out on government services, and workers faced working conditions that were often unsafe, overcrowded, and contaminated with dangerous chemicals. The results were financial crises, like the stock market crash of 1929, and a general decline in economic and social standards.
Corrupt officials may grease the wheels of bureaucratic practice, making it easier for firms to obtain necessary permits and licenses, but that “greasing” effect is likely mediated by other institutional components. In this paper, we test the impact of corruption and other institutional features (democratic accountability, law and order, and bureaucratic quality) on changes in stock market returns (SR). We use a panel two-way fixed effects model with monthly data on BRIC countries.
We find that a one-percentage point increase in corruption reduces SR, but the impact becomes smaller as democratisation matures within the country, suggesting that some form of “good” corruption helps lower regulatory burdens on firms and enhances SR.
Our findings suggest that policies that focus solely on reducing corruption risk have little effect in developing economies where the cost of doing business is high and firm productivity low to begin with. In such circumstances, reducing corruption might not be cost-effective unless it also improves the quality of institutions that secure property rights and promote growth. Moreover, in these contexts, voluntary corruption control measures can only go so far since non-compliant firms stand to gain business contracts that would have gone to compliant firms, offsetting any marginal benefits of reduced corruption.