Corruption and the Composition of Public Expenditures: Evidence from OECD Countries

This paper analyzes how corruption affects the composition of public expenditures. First, a two-stage rent-seeking model with endogenous rent-setting is derived that captures both "political corruption" and "bureaucratic corruption". The model illustrates how asymmetries between industries in the degree of competition and in the difficulty of concealing bribery may influence the allocation of public spending. The theoretical implications are tested with a panel dataset for 26 OECD countries over the 1996 - 2008 period. The results suggest that the shares of spending on health and environmental protection increase, while the shares of spending on social protection and recreation, culture and religion decline with higher levels of corruption. The significance of these distortions is robust to a variety of specifications such as fixed effects, random effects, seemingly unrelated regressions, the inclusion of additional controls, and the use of alternative corruption indicators.