The Persistence of Corruption and Regulatory Compliance Failures: Theory and Evidence

This paper examines the reasons why corruption and policy distortions tend to exhibit a high degree of persistence in certain regimes. We identify circumstances under which a firm seeks to evade regulations through (i) bribery of local inspectors, and (ii) by lobbying high-level government politicians to resist legal reforms designed to improve judicial efficiency (rule of law) and eliminate corruption. We show that in some cases political instability reinforces these tendencies. The analysis predicts that in politically unstable regimes, the institutions necessary to monitor and enforce compliance are weak. In such countries, corruption therefore is more pervasive, and the compliance with regulations is low. We test these predictions using cross-country data. The empirical results support the predictions of the model. Political instability reduces judicial efficiency, which in turn stimulates corruption. Thus, the effect of political instability on corruption is not direct, but occurs indirectly via its effect on the degree of judicial efficiency. Finally, corruption lowers the level of regulatory compliance. Thus, political instability indirectly affects compliance, via judicial efficiency and corruption.