Government effectiveness has emerged as an important factor in the relationship between corruption and the process of financial development. This chapter explores the relationship between corruption control, government effectiveness and financial development in 14 low- and high-income countries over the period 2005–2020 to determine the applicability of the grease the wheels and the sand the wheels hypotheses. Panel data for the two country groups were analysed after overcoming heterogeneity and endogeneity issues. Diagnostic tests were used to increase robustness. The analysis revealed that an increase in corruption control led to a decrease in financial development due to highly effective governments in high-income countries. In contrast, an increase in corruption control led to an increase in financial development due to inefficient governments in low-income countries. The main conclusions of the study are that the grease the wheels hypothesis is applicable to high-income countries and the sand the wheels one is applicable to low-income countries.
Top1. Introduction
Corruption has become a pivotal factor in the development of economies. As such, Dincer (2019), Ades and di Tella (1999) and others have focused on the following question in various ways: Does corruption help or hinder the process of financial development? In addition, government effectiveness has emerged as an important factor in this relationship. For example, Ehrlich and Lui (1999), Adsera et al. (2003) asserted that government effectiveness plays a prominent role in the project start-up process by facilitating or hampering the provision of governmental advantages and any needed facilities. Government effectiveness also affects taxation, which is an integral part of the project development process.
During the last three decades, international organisations, national governments and non-governmental organisations have prioritised the issue of corruption and confronted the risks it brings to economic and social sectors. The increasing interest in this topic stems from the costs of economic and social corruption, which affect various sectors of society. Among the most important are the effects on investments and economic growth. Park and Khanoi (2017) defined corruption as the abuse of power to achieve private interests. Meanwhile, Shumetie and Watabaji (2019) and Rose-Ackerman (2009) defined corruption as a dishonest and illegal shock. Özbaran (2003) indicated that corruption is the use of the authority of officials to achieve special interests.
The risks surrounding corruption span all economic sectors. However, corruption has the greatest impact on financial institutions, since the financial system is an important part of a state’s economy that attracts local and foreign investments and works to provide funds to all economic sectors for the development of society (Shahbaz & Rehman, 2012; Anwar & Nguyen, 2010). Financial sector development enhances economic growth through the advanced technologies used in all financial transactions as well as the accumulation of capital (Dincer, 2019). Financial sector development refers to the financial sector, which seeks to enhance investment by exploiting opportunities to build a strong business sector that engages in business through contracts to hedge any risks and has a diversified investment portfolio as it keeps future savings; this is called the reallocation of resources (Ades & di Tella, 1999).
In addition to the link between corruption and the financial system, this also depends on government effectiveness (Ahmad & Saleem, 2014; Rafay, 2023), which is an indicator used to ensure the integrity of transactions and the efficiency of the bureaucracy and enable infrastructure maintenance in order to support the exchange of goods and the provision of services (Levi, 2006). The World Bank (2018) defined government effectiveness as the degree of awareness of the quality of services and their independence from political pressures.
The academic debate about corruption can be cast from different points of view. For example, Dreher and Gassebner (2013) depicted corruption as an obstacle to the achievement of economic growth and social development by private companies. Others have stated that bribery hinders competition, increases potential public health risks, distorts the incentives granted to companies and lowers ethical standards (Budsaratragoona & Jitmaneerojb, 2020; Beekman et al., 2013). Aidt (2009) and Fisman and Svensson (2007) described corruption as reducing growth by imposing a tax It is a great deal of innovative activity. He also noted that bribery increases production costs for companies and reduces investment due to low returns. Mauro (1995), Brunetti and Weder (1998) and Mo (2001) identified a significant negative relationship between corruption and investment and showed that it hindered economic growth. As a result, international organizations (e.g., the IMF, the World Bank, the UN, and the OECD) have made the fight against corruption a high priority.