Abstract
Corruption impacts the competitive conditions among firms and the flow of foreign investment. Institutional reforms made for fighting against corruption are sometimes useless. We develop a model in which a corrupted government tries to set an optimal institutional level taking into account the cost of this policy on foreign investment, the benefit of a corrupted domestic firm and the benefit of local citizens. A political contribution is made by a corrupted lobby group in order to benefit from a lower institutional level. Our results suggest that the optimal institutional level depends on the degree of efficiency of firms and the level of corruption of the host government.
Highlights
We model lobbying by following the political contributions approach
With this strict institutional policy, the benefit obtained by the entry of multinationals plus the benefit in the income of honest people overcome the loss in efficiency of the domestic firm
An increase in the corruption parameter increases the weight attached to the political contribution the domestic firm is willing to pay in order to obtain a competitive advantage over multinationals
Summary
We consider institutional reform a legal change that reduces the incentives to bribe corrupt government officials working within the illegal structure of the fiscal system. Under this assumption, (20) shows that an increase in the institutional level reduces the optimal output of the domestic firm since there is an increase in the cost by changing from the illegal (and cheaper) to the legal (and more expensive) structure to pay tax obligations.
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