Abstract
We investigate the role of corruption in the business environment in explaining the efficiency of within-sector production factor allocation across firms in nine Central and Eastern European (CEE) countries in 2003-2012. Using a conditional convergence model, we find evidence of a positive relationship between corruption growth and both labour and capital misallocation dynamics, once country framework conditions are controlled for: this link is larger the smaller the country, the lower the degree of political stability and civil liberties, and the weaker the quality of its regulations. As input misallocation is one of the determinants of productivity growth, we further show that the correlation between changes in corruption and TFP growth is indeed negative. Our results also hold when we tackle a possible omitted variable bias by instrumenting corruption with two instrumental variables (the percentage of women in Parliament and freedom of the press). In conclusion, targeted action against corruption in the CEE region would be efficiency-enhancing.
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