CORRUPTION: TOP DOWN OR BOTTOM UP?

Abstract

This article studies the impact of corruption on an economy with a hierarchical government. In particular, we study whether centralizing corruption within the higher level of government increases or decreases the total amount of corruption. We show that when the after‐tax relative profitability of the formal sector as compared to that of the informal sector is high enough, adding a layer of government increases the total amount of corruption. By contrast, for high‐enough public wages and/or an efficient monitoring technology of the bureaucratic system, centralization of corruption at the top of the government hierarchy redistributes bribe income from the lower level to the upper level. In the process, total corruption is reduced and the formal sector of the economy expands.