The Dutch disease, which refers to the debilitating consequences on a country’s economy of a windfall gain from natural resources, has been a subject that has been studied at much length. These studies explain the process through which such a windfall can lead to a decline in income, via an appreciation of the exchange rate. In the broader sense, it refers not just to the discovery of natural resources, but also foreign investment that may have the same effect.
But can an increase in resources lead to an increase in political corruption and can it lower the quality of governance? That is the question that several researchers from Bocconi University in Italy try to answer in their paper on The Political Resource Curse.
The authors study the impact of an increase in federal transfers to municipalities in Brazil. Local taxes account for a fraction of the total revenues of these municipalities, the bulk of their resources being obtained from the federal government through fund transfers that are based on the population of a municipality.
The subject is important not just for Brazil but for any country or region whose federal government transfers resources to its poorer regions. The authors cite the example of some European Union funds and international aid to poorer countries.
But the issue is also very relevant for a country like India, where the Centre shares its tax kitty with the states on the basis of pre-determined criteria, including backwardness. As the authors point out, “Since a common cause of economic backwardness is precisely the poor functioning of government institutions, the risk that these additional resources could be counterproductive cannot be neglected.”
Illustration: Jayachandran / Mint
So what do the authors find? Their results show that a 10% increase in federal transfers to municipalities in Brazil raised local corruption between 17% and 24%. They use audit reports on the municipalities to check on instances of corruption, such as illegal procurement practices, diversion of funds, over-invoicing of goods and services, and fraud.
That’s not all—they also find that “this fiscal windfall increases the incumbent mayor’s probability of re-election by 7%, and shrinks the fraction of his opponents with a college degree by 7%”. In other words, the federal transfers not only helped corrupt mayors make money, they also increased their chances of re-election, thus worsening governance.
To be sure, a portion of the extra funds may be spent on things that help the people, like education and health. Nevertheless, say the authors, the “evidence suggests that these specific benefits are accompanied by a general deterioration in the functioning of local government institutions”.
Why will an increase in external funds lead to more corruption? The paper says that’s because “with a larger budget size, the incumbent has more room to grab political rents without disappointing rational but imperfectly informed voters”.
The authors also say that higher budgets lead to lower quality of politicians. Why does that happen? Explain the authors: “Because the value of rents is higher for the low quality mayors, a larger budget increases the value of office by more for the low quality than for the high quality candidates. Hence, at the margin more low quality candidates enter the pool of opponents, deteriorating the composition.” In other words, more talented people have better opportunities outside politics and the rents may not be as attractive to them as to others.
That’s a dubious reason, given the size of the “opportunities” that politicians enjoy. But the research should lead to questions on the undesirable side effects of grants to underdeveloped states in India.
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