Corruption, Government Effectiveness, and Financial Development

Abstract

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.