Does Corruption Grease or Sand Innovation? Evidence of an Inverted U-shape Relationship between Corruption and Innovation in Transition Economics

Aleksandra Dimovska & Ivana Barbir

Student thesis: Master thesis

Abstract

The main purpose of this thesis is to establish the link between corruption and innovation in transition economies, as we believe the relationship to be more complicated than suggested by previous research. We study the relationship between corruption and innovation by looking at how different corruption levels and institutional quality settings change the corruption-innovation link. Using data from the fifth round of the Business Environment and Enterprise Performance Survey that includes a sample of firms from thirty transition economies, we find a non-monotonic relationship between corruption and innovation. Low levels of informal payments enhance innovation while high levels decrease the propensity to innovate. This inverted U-relationship holds for innovations requiring government interaction. Various dimensions of institutional quality and governance are interacted with the level of informal payments where the results show that high institutional quality diminishes the effect of corruption. Hence, corruption can be seen as a substitute for effective and functional institutions. To our knowledge, estimating a non-linear relationship between firm-level corruption and innovation has not been attempted before. However, the findings of this thesis are in line with the previously found U-shaped relationship between country-level corruption and economic growth. In order to deal with potential endogeneity of corruption, an IV probit model is used. Our results are robust to various econometric specifications where both validity of instruments are tested and alternative control variables are used. To investigate heterogeneity between firms, a subsample analysis is performed where internal and external dimensions related to relationship-building with government and country-level aspects are studied. The results of the subsample analysis suggest that relationship-building between firms and government officials, transition progress and EU membership significantly affect the corruption-innovation link.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2016
Number of pages119
SupervisorsC├ędric Schneider