Corruption, Pricing of Public Services, and Entrepreneurship in Economies with Leakage

The paper presents a theoretical model of an economy with bureaucratic corruption where bribe income can leak out of the economy. In a high-leakage economy, a welfare-maximizing government sets the price of public services above the unit cost of provision, which deters entrepreneurship, whereas in more prosperous economies the price falls to the unit cost level. In both cases, the government allows some degree of corruption. The model generates interesting policy implications: In low-prosperity economies the control of leakage may induce a higher level of corruption, while in high-prosperity economies it is an ineffective instrument in controlling corruption. The above findings are robust across specifications.