Abstract
A political economic framework is used to describe an economy following transition to private ownership. Thetransition, characterized by massive privatization, is accompanied by a change in the legal system, which isinfluenced by the elite who may be described as either corrupt or non-corrupt. The ability of the corrupt elite toinfluence the ruling party may lead to weak legal institutions, which cause underinvestment, corruption, andcapturing of lucrative industries by corrupt investors. By introducing heterogeneity among industries, we extendthe literature and show that the corrupt investors corrupt the more lucrative industries, and in corrupt economiescorrupt investors may separate themselves from the non-corrupt investors. Furthermore, we identified twomethods used by the corrupt investors to siphon profit – output stealing and profit stealing – and illustrate thatcorrupt investors may substitute between the two methods to alleviate the constraints created by strongerinstitutions. To this end, strengthening the institutions only in one dimension may, at the end of the day, causeoutput, as well as investment, to decline.
Highlights
In the latter part of the 20th century, we witnessed transition from centralized regimes to market regimes (Bulgaria, Poland, and Russia, to name a few)
Different from the literature that investigates the role bribes to the government play in income transfer (Grossman & Helpman, 1994 and 1995; Dixit et al, 1997; Bulte, Damania, & Lopez, 2007; among others), this paper focuses on how corrupting transition is used by corrupt investors to expropriate others, and shows how this process leads to corruption of some industries, but not others
Given that we assume the economy is clear of any type of corruption or theft, there is no role for the rule-of-law coefficient (RLC); for completeness, we assumed 1
Summary
In the latter part of the 20th century, we witnessed transition from centralized regimes to market regimes (Bulgaria, Poland, and Russia, to name a few). This paper presents a model of transition which strives to characterize some of the underlining forces that cause corruption to infiltrate lucrative, as well as shadier, industries To this end, we view transition as a process which is characterized by three facets: (1) establishment of market-based rule of law; (2) privatized economy and change in ownership from public to private hands; and (3) the movement of economy to profit-maximizing behavior, where some, but not all, owners divert the firm’s profit and output to their own benefit. We draw from the literature on interest groups and menu auction (e.g., Bernheim & Whinston, 1986; Grossman & Helpman, 1994 and 1995; Dixit, Grossman & Helpman, 1997) to illustrate that political constraints may corrupt the transition to market regime This distortion can lead to underinvestment (see Brunetti & Weder, 1997; Knack & Keefer, 1997; Mauro, 1995; Lambsdorff, 1999; among others).
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