Education, Corruption, and the Distribution of Income * Theo Eicher University of Washington. Cecilia García-Peñalosa a GREQAM and CNRS

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1 Edcaion, Corrpion, and he Diribion of Income * Theo Eicher Univeriy of Wahingon Cecilia García-Peñaloa a GREQAM and CNR Tangy van Yperele GREQAM and CEPR December 2007 Abrac: We model he wo way ineracion beween edcaion, corrpion and he level of op. Corrpion redce income level and hence edcaional aainmen. Edcaion in rn affec he incenive for corrpion: more edcaion increae op and h he ren from corrpion, b i alo increae he probabiliy ha he elecorae idenifie corrp behavior and o he incmben pary. In hi conex, we idenify he condiion nder which an opporni pary ha he incenive o ake acion ha will allow he economy o ecape from a povery rap. Or analyi how ha he relaionhip beween edcaion, op level and he level of corrpion i non-monoonic, and ha boh iniion-led developmen and edcaion-led developmen are poible. Which pah occr crcially depend on he iniial level of ineqaliy. Key word: Ineqaliy, corrpion, edcaion, economic developmen. JEL Claificaion: O1 * We are graefl o eminar paricipan a GREQAM, he Univeriy Carlo III of Madrid, he Eropean Univeriy Inie, and he 2007 PEGNe conference. a Correponding ahor. GREQAM, 2 re de la Charié, Mareille, France. penaloa@ehe.niv-mr.fr

2 1. Inrodcion I i well eablihed ha edcaion i aociaed wih greaer elecoral paricipaion, 1 and a nmber of ahor have died he implicaion ha he relaionhip beween edcaion and paricipaion ha for economic developmen; ee, for example, Borgignon and Verdier (2000). Wha ha received le aenion i he fac ha edcaion alo affec individal capaciy o ae policie and parie behavior. In hi paper we examine he idea ha, in a democracy, a more edcaed elecorae ha a greaer capaciy o idenify corrp parie and hence can redce ren-exracion by he poliical cla. Thi generae wo-way relaionhip beween corrpion and edcaion ha can help nderand ome of he empirical pzzle concerning edcaion, iniional qaliy, and developmen. There exi banial empirical evidence ha edcaion improve poliical knowledge. rvey daa docmen ha more edcaed individal beer idenify he qaliy of poliical iniion, parie, and implemened policie, and ha edcaion improve individal abiliie o comprehend poliical even and form conien poliical view (ee Galon, 2001, Delli Carpini and Keeer, 1996, and Nie e al., 1996). Individal wih lower level of poliical knowledge have been hown o be more likely o rely on characer impreion raher han policy evalaion in heir voing behavior (Popkin and Dimock, 1999, ee Galon, 2001, for a rvey). More edcaed individal are alo more likely o ake civic engagemen, ch a wriing leer o newpaper or conacing pblic official (Glaeer, Ponzeo, and hleifer, 2007). Recen work ha highlighed he role of informaion and edcaion in redcing corrpion. Reinikka and venon (2005) find ha, in Uganda, a newpaper campaign informing paren and chool of he fnd provided by he governmen for edcaion banially redced he fracion of he fnd capred by local poliician and increaed re pending in edcaional infrarcre. Thi indicae he poenial role of informaion in prevening corrpion. Glaeer and ak (2006) arge ha edcaion end o increae convicion for corrpion, and find ppor for hi argmen ing hiorical daa for U ae. Or analyi i baed on wo crcial mechanim relaing edcaion wih he behavior of he pary in governmen. On he one hand, an hone pary e lower ax 1 ee for example U.. Deparmen of Edcaion, (2003).

3 rae han a corrp one, which increae he ne income of he poplaion and allow more individal o afford edcaion. On he oher hand, more edcaed individal have wo oppoing effec on he pary payoff from corrpion. More edcaion increae op and hence poenial corrpion ren, b i alo lower he reelecion probabiliy of a corrp incmben ince edcaed voer are more likely o idenify corrp parie. A a rel he expeced payoff from corrpion i non-monoonic in he average level of edcaion. The raegic behavior of parie i he key elemen in or analyi. We find ha nder cerain circmance, opporniic parie may behave honely, or even pa wha we erm coniional reform, which improve ranparency and preven fre corrpion, h bringing he economy o of a povery rap. Which raegy dominae crcially depend on wo hing: he level of edcaion and he degree of wealh ineqaliy. Edcaion i crcial a i deermine boh he crren level of ren and he probabiliy of being idenified a corrp. The degree of ineqaliy, in rn, deermine he nmber of individal ha can become edcaed and hence fre ren. We find ha i i conrie wih inermediae level of edcaion ha are mo likely o be ck in a povery rap. The raegic deciion of opporniic parie lead o corrpion for inermediae level of edcaion, and o hone behavior for high and low level of hman capial, implying ha a he aggregae level he relaionhip beween edcaion, corrpion and op i non-monoonic. Or analyi how ha here are wo way in which an economy can ge o of a povery rap. Economic developmen can be led eiher by poliical reform which rel in low axaion and hen generae edcaion expanion, or by an iniial accmlaion of hman capial ha evenally force parie o behave honely. Thi mlipliciy of developmen pah can help nderand why he empirical lierare ha had o mch difficly in idenifying wheher i i good iniion ha cae edcaion, or wheher edcaion lead o good iniion; ee Acemogl, Johnon and Robinon (2001, 2002) and Glaeer e al. (2004). We explore he circmance nder which one or he oher pah o developmen i likely o ake place, and find ha iniial wealh ineqaliy play a crcial role in deermining which of hem i followed. Or rel are in line wih he evidence provided by Eaerly (2005), who afer careflly inrmening for ineqaliy, find ha an neqal diribion i a major impedimen o properiy, good iniion, and high edcaional achievemen.

4 The paper add o he growing lierare on endogeno poliical paricipaion. Exiing model have examined he implicaion when elecoral paricipaion depend on he level of edcaion and hey have alo conidered yem in which agen voe direcly on he exen of rediribion. Cloe o or analyi are Acemogl and Robinon (2000) and Borgignon and Verdier (2000). The poliical elie in Borgignon and Verdier face a imilar rade-off a he pary in or model: increaed edcaion lead o higher income for he elie (de o a echnological exernaliy) b alo o increaed elecoral paricipaion, and hence more rediribion. However, heir model generae a monoonic relaionhip beween iniial income, edcaion, and he exen of democraizaion, which ha proven difficl o confirm empirically. Or analyi hare wih Acemogl and Robinon (2000) he idea ha hoe in governmen may be inereed in commiing o iniional change which limi heir power in order o maximize heir long-erm well being. For Acemogl and Robinon i i he hrea of revolion ha force parie o exend franchie and commi o rediribion in he fre; in or ep i i he hrea of no being reeleced ha can lead o he inrodcion of coniional reform. Oher recen paper have emphaized he endogeneiy of iniion; ee Aghion, Aleina, and Trebbi (2004), Cervellai, nde and Fornao (2006), and Galor, Moav and Vollrah (2006). Glaeer, Ponzeo, and hleifer (2007) examine he crcial role of edcaion in bringing abo democracy. The key apec of heir analyi i ha edcaion increae ocial involvemen and hence rel in greaer acive ppor for democracy. In or ep, ocial involvemen ake he form of beer monioring of poliician wihin a democracy, and hi ha imporan implicaion for aggregae behavior. Or work i alo relaed o he recen lierare on corrpion. One rand of he lierare ha ried o nderand he incenive for corrpion and ren-eeking in a aic conex. 2 Anoher rand ha examined he impac of corrpion on growh, following he eminal work of Maro (1995, 1997) who find empirical ppor for he idea ha more corrpion redce growh. Only a limied nmber of paper have developed dynamic model of growh and corrpion; ee Mohad and Ror (2003) and Blackbrn e al. (2002). In pariclar, he relaionhip beween edcaion and corrpion ha received lile aenion. Two noable excepion are Ehrlich and Li 2 Thi lierare ared wih Kreger (1974). For recen work on he deerminan of corrpion ee hleifer and Vihny (1993), Bli and Di Tella (1997), Ade and Di Tella (1999), or Emeron (2006).

5 (1999) and De La Croix and Delavallade (2006). Ehrlich and Li have examined he effec of corrpion on growh when agen chooe how o divide heir ime beween he accmlaion of hman capial and ren-eeking aciviie. However, heir foc i on he diverion of reorce ino ren-eeking. De la Croix and Delavallade explore he idea ha endogeno corrpion affec he ype of pblic expendire, divering reorce from growh-enhancing hman capial accmlaion o oher ype of expendire. The paper i organized a follow. ecion 2 decribe he prodcion ecor and edcaion deciion, ing he overlapping-generaion model wih imperfec capial marke developed by Galor and Zeira (1993). I how how he ax rae affec beqe and he level of hman capial, and highligh he role played by iniial ineqaliy. ecion 3 inrodce he poliical rcre of he model, in which a elfinereed pary chooe he ax rae. ecion 4 examine he raegic behavior of he pary a a fncion of iniial edcaion and wealh ineqaliy. We hen examine he dynamic of edcaion, and characerize he poible developmen pah. ecion 5 conclde. 2. Prodcion, Edcaion and Taxaion 2.1. Decripion of he Economy The prodcion and edcaion rcre follow Galor and Zeira (1993), 3 o which we add a proporional income ax ha i levied in order o finance a pblic good Prodcion Conider a mall, open economy wih killed and nkilled labor, denoed L and L U, repecively. killed and nkilled worker prodce op in eparae, compeiive ecor denoed by j, wih j =,. The prodcion fncion are given by, 1 ( A L ) α Y = α j K j j j 0 < α < 1 (1a), where K and A repreen phyical capial and echnology, repecively. We ame A > A, implying ha echnology ed by killed worker i more prodcive. 3 We refer he reader o he original paper for a deailed dicion and moivaion of he ampion. ee alo Galor and Moav (2004, 2006) for work on he long-rn relaionhip beween ineqaliy, edcaion and income level.

6 Firm can borrow a he conan world inere rae, r. All income i axed a rae τ, where he ax rae i deermined endogenoly in he poliical proce a will be pecified in ecion 3. Eqaliy beween he world inere rae and he domeic afer-ax rern on capial deermine he amon of capial employed in each ecor. 1/ The capial-labor raio are given by ( ( ) ) ( 1 k = A α 1 τ r α ) A a rel, wage, wih where ( ) ( ) α / ( 1 λ = α α α ) j A j 1 r k K / L. j j, where j j j w j, are independen of he pplie of he wo ype of worker, α /(1 α ) w j = λ j (1 τ ), (2). Noe ha he wage depend negaively on he ax rae, hrogh he effec ha he laer ha on he capial ock. Uing he labor marke clearing conrain, L L = 1, aggregae op can be expreed a U + Y Y + Y = (1 τ ) λ (1 L ) + λl 1 α α /( 1 α ) Higher axe depre op while an increae in he fracion of he labor force ha i edcaed raie op. We ame ha prodcion reqire he proviion of a pblic good, which can be hogh of a an infrarcre reqiremen. We follow García-Peñaloa and Trnovky (2005), and ame ha (1b) φ Y ni of he pblic good are reqired o prodce a level of op Y, wih 0 < φ < 1. The pblic good ha a conan ni co, c, implying ha he oal co of he pblic good i cφ Y Edcaion, Conmpion and Beqe There i a ma 1 of overlapping-generaion dynaie indexed by i. Agen live for wo period, implying ha he poplaion meare i 2. Agen differ in heir iniial wealh, wih all he killed worker holding wealh x, 0 and all he nkilled x < x a ime 0. The iming i a follow: a he beginning of her fir period of, 0,0 life an individal receive a beqe from her paren and decide wheher or no o inve in edcaion. Edcaion ake no ime. he hen work for ha period a eiher killed or nkilled, and ha an offpring a he end of he period. In he econd period, he doe no work, conme and leave a beqe o her child. There are elecion a he beginning of each period, and all agen voe in hem.

7 Each worker derive iliy from her own conmpion, c i, and he beqe lef o her offpring, b i, wih he iliy fncion aking he form 1 β ci bi U i =, where β < 1. (3) 1 β β Uiliy opimizaion implie ha conmpion and beqe are conan fracion of per capia op, i = ( 1 β yi and i, = yi, = xi, + 1 c ) β b β, where x i, + 1 i he inheriance ha a yong individal from dynay i receive from her paren, i.e. her wealh. biing for conmpion and he beqe, he indirec iliy fncion i given by U i = y i. (3 ) We ame here i a fixed edcaion co, e, and ha borrowing o finance edcaion i no poible. 4 The income of an nkilled and a killed agen are hen [(1 ) w ( x ] y = τ ) +, (4a) y, (1 + r) τ [(1 ) w ( + ( x e) ] = (1 + r) τ ). (4b), τ Afer receiving heir beqe, yong agen decide wheher or no o dy. A neceary condiion for invemen in edcaion i hen ha heir beqe i large enogh o cover he co of edcaion, i.e. x i e. Wealhy agen hen inve in edcaion if he lifeime income of being killed i higher han ha of being nkilled, ha i, if y > y. Thi ineqaliy redce o he condiion ha he rern o edcaion i greaer han he inere an agen cold obain from inveing e in phyical capial, ha i, (1 τ ) 1/(1 α ) [ w ( τ ) w ( τ )] = (1 τ ) ( λ λ ) e Noe ha hi eqaion i independen of he agen wealh, implying ha if i i aified, all agen wih o become edcaed. Frhermore, hi eqaion implie ha a low enogh ax rae 1 [ /( λ λ ( τ )] α ˆ τ 1 e. τ ˆ < τ i reqired for agen o wan o dy, where Dynamic The dynamic of he model are given by he evolion of beqe; hey are characerized by he wo difference eqaion: 4 None of or rel wold change in he more general cae in which borrowing o inve in edcaion i poible b coly de o imperfec capial marke, a in Galor and Zeira (1993).

8 1/(1 α ) ( λ (1 τ x ) 1/(1 α ) ( λ (1 τ + x e) x, + 1 = ( 1+ r) ) +, The beqe of all dynaie wih wealh hoe of dynaie wih beqe β, (5a) x, + 1 = β (1 + r) ), (5b) x < e are governed by eqaion (5a), while x e are governed by (5b). Thee wo fncion are depiced in Figre 1, where he lower line repreen he beqe fncion of he nkilled and he higher one he beqe fncion of he killed. Under he ampion of a conan ax rae and ( 1+ r ) β < 1 (which occr if he propeniy o beqeah i no oo large), hee wo fncion inerec he 45 degree line and converge o he eady ae, + 1 = x, x and x, + 1 = x, = x. x = Figre 1 abo here Aming a conan ax rae, he long-rn diribion of wealh converge o an invarian diribion which i a fncion of he iniial diribion; ee Galor and Zeira (1993). The long-rn level of wealh held by he nkilled and by he killed are, repecively, [] τ β ( 1+ r) 1/(1 α ) = λ (1 τ ) x, (6a) 1 β ( 1+ r) 1/(1 ) ( λ (1 τ ) e) β ( 1+ r) α x [] τ =, (6b) 1 ( 1+ r) β while he eady ae fracion of killed (nkilled) worker i given by he proporion of dynaie whoe iniial wealh exceed (fall below) he co of edcaion. Galor and Zeira dic he eqilibrim a lengh. They examine he role of he prodcion fncion (echnology and inere rae), and he iniial diribion of wealh in deermining he feaible eqilibria. Here, we are inereed in he poliical economy of axaion and hence inveigae he impac of he ax rae on he edcaion deciion. An eqilibrim wih ineqaliy reqire a ax ch ha rich dynaie can afford edcaion, while poor dynaie canno, i.e. hi implie a ax in he inerval [ τ, ˆ τ ], whereτ = x (τ ) e and x (τ ) < e. From (6) 1 α 1 ( e (1 β (1 + r)) β (1 + r) λ ). Any ax rae lower han τ allow a decenden of hoe crrenly nkilled o

9 evenally dy, while any ax greaer han τˆ implie ha even he children of he killed are no able o afford edcaion in he long-rn. In wha follow we ppoe Ampion 1: The iniial ax rae τ 0 and iniial diribion of wealh are ch ha he iniial eqilibrim exhibi ineqaliy. Tha i, 0 τ, ˆ τ and x < e < x., 0,0 τ ( ) We make ampion 1 in order o foc on he inereing cae of an iniially neqal ociey. The analyi of how poliical corrpion and reform affec edcaional aainmen wold be irrelevan if all worker cold afford edcaion from ime = Dynamic Effec of Taxaion We can now analyze he impac of ax change on income and beqe, and hence on he diribion of income and edcaional aainmen. Lower axe have a direc and an indirec effec on individal income: for a given wage, lower axe increae dipoable income; hey alo increae he ne rern o capial, leading o a capial inflow ha raie all wage. Thee wo effec hif pward he beqe fncion, implying a higher beqe a + 1 for any given beqe a, a depiced in figre 1. The impac on edcaion depend on wheher he ax level i higher or lower han he hrehold τ. Any ax rae τ > τ generae an eqilibrim wih ineqaliy repreened by ( x, x ). The redcion of he ax o a level below τ wold hif he beqe fncion fficienly for he fixed poin of he nkilled beqe fncion o diappear, a depiced in Figre 2. Coneqenly, all dynaie end p being killed in he long-rn wih a beqe level of ' x. Thi eqilibrim rel in higher op and complee eqaliy. Thee change may, however, ake ime depending on he iniial level of ineqaliy. Figre 2 depic he dynamic adjmen of he economy in repone o a 1 redcion in he ax rae from τ 0 o τ < τ. The ax redcion hif p he beqe chedle, which increae he wealh of he nex generaion. If he iniial wealh level of he nkilled a i low, for example x 0, heir offpring will receive an inheriance of x 1 which i le han he co of edcaion. They will hence be nable o dy and

10 he killed labor pply a +1 will be eqal o ha a. ome decenden of hi dynay will evenally be able o dy, b i will ake ime. Now ppoe ha he iniial level of wealh of he nkilled i high, a x. In hi circmance hey will leave a beqe o heir offpring will be x 1 ' > e, implying ha all hoe born a +1 will be able o afford edcaion and he killed labor force a +1 will be eqal o 1. Figre 2 abo here In or wo-cla economy, we can define he degree of ineqaliy a he diance beween he iniial wealh of he edcaed and ha of he non-edcaed, x x. For a given level of average wealh in he economy, and given he killed, 0,0 and nkilled poplaion, a lower vale of x, 0 implie greaer ineqaliy. Then, he degree of ineqaliy deermine how many period of low axe are needed for he poor o be able o afford edcaion. We denoe he nmber of period needed by N. From figre 3, i i clear ha he lower x, 0 (i.e. he greaer ineqaliy i), he larger N will be. 5 We can mmarize he rel on he effec of ax change on edcaion a follow: Propoiion 1: Dynamic Effec of Tax C A redcion in he ax rae from τ 0 o L 1 τ < τ lead o a flly edcaed labor force, = 1, and o an eqal diribion of wealh. The higher he degree of iniial wealh ineqaliy, meared by x 0 x, 0, he greaer he nmber of period N ha i will, ake o achieve edcaion expanion. Having eablihed he relaionhip beween he edcaion and he diribion of wealh in repone o a change in axe, we can now rn o examine how he level of edcaion and ineqaliy affec corrpion. 5 Noe, however, ha ince x, 0 i conino and N dicree, he fncion N ( x, 0) will be a ep fncion.

11 3. Poliical Economy 3.1. Poliical Ren There are many poenial parie, all of which are infiniely lived. A ingle pary i eleced each period in order o provide a pblic good. There are wo orce of poliical ren. On he one hand, here i an ego ren derived from being in power a period, denoed ; on he oher, here may be moneary ren, denoed π, which he pary receive if i behave corrply a. We ppoe ha he co of he pblic good cφ Y i no known o he elecorae, and hi i wha creae he poibiliy for corrpion, defined a he pockeing of par of he ax revene by he pary. ince ax revene i given by τ Y, he ax rae neceary o finance he pblic good i τ c = cφ. We will erm hi he compeiive ax rae. The pary cold, however, claim ha he co of proviion i c greaer han i acally i, and e a higher ax rae, τ τ. The difference beween ax revene and expendire in he pblic good hen generae moneary ren ha will be pockeed by he pary in power. Moneary ren are given by π = ( τ c φ) Y, (7) and, for given aggregae income, are increaing in he ax rae. However, a we aw in ecion 2, a higher ax rae redce he capial-labor raio and hence aggregae op. Thee wo oppoing force imply ha ren are a concave fncion of τ, hence he pary will chooe he ax rae ha maximize ren from corrpion. Uing (1b) o bie for Y, we obain he ax rae ha maximize ren, * τ = 1 α(1 cφ), and he ren obained by a corrp pary a ime, namely ( ϕ ) L 2 where = A ( 1 α ) ( α r ) ( ) ( 1 cφ ) ( ), (8) π = a 1 +, (9) 2 α / 1 α 1 / 1 α a and ϕ A / A 1. Clearly, a = higher level of edcaion rel in a larger ren, a hi increae he ax bae. Ren alo increae in he level of nkilled prodciviy, A, and he kill premim, A / A, and decreae in he world inere rae, r, and he co of providing he pblic good, c. The analyi of corrp regime wold be irrelevan if corrp axe were aociaed wih eqaliy, eiher becae hey allow all agen or none o dy. Hence

12 we inrodce Ampion 2 o enre ha poliical reform can have an impac on he level of edcaion: c Ampion 2: The compeiive ax rae aifie τ < τ, while he corrp ax rae τ * lie in he range ( τ, ˆ τ ). Thi ampion i aified for an inermediae range of he co of providing he pblic good. If he co i oo high, even he compeiive ax rae will be oo large for he wealhie individal o dy; if he co i oo low, all dynaie will be able o afford edcaion even when τ * i impoed. Ampion 2 hen implie ha when he corrp ax rae τ * i choen he level of edcaion i nchanged, while nder he c compeiive ax rae τ all dynaie can evenally dy The Poliical Proce A he beginning of each period an elecion ake place o elec he pary in power for a erm ha la one period. The pary may be reeleced, and he probabiliy of elecion depend on he pary acion and he level of edcaion in he economy, a will be pecified below. The pary in power can nderake wo acion. Fir, i annonce he co of he pblic good and e he ax rae for ha period. I can e a compeiive ax, τ c, in which cae we ay i i hone, or claim ha he co of he pblic good exceed c, * c charge τ > τ, and pocke he exce ax revene, in which cae we ay i i corrp. econdly, irrepecive of he ax rae choen, i may decide o pa coniional reform. Coniional reform i modelled a a move oward complee ranparency regarding c: he re co of he pblic good i annonced and become known o all agen. 6 Once coniional reform i nderaken, i remain in place, implying ha fre parie canno levy axe in exce of τ c. Tha i, fre corrpion i no 6 The imporance of bdge iniion and, in pariclar, he role of ranparency in generaing fical dicipline i docmened by Aleina, Hamann, Homme, and ein (1999). Compelling evidence for or concep of coniional reform i preened by Walli (2005), who examine coniional reform a he ae level in he U ae in he mid-nineeenh cenry. Major ranpor infrarcre projec were ridden wih corrpion ha led o a fical crii in he early Many ae reponded by wriing new coniion ha increaed he ranparency of governmen borrowing and expendire, and cceeded in redcing corrpion.

13 poible. Coniional reform i paed a he end of he period, implying ha a reform paed in will be applicable from +1 onward. We ppoe ha here are wo ype of parie, ideali and opporni, b ha he ype can no be oberved by voer. There i a mall proporion of ideali parie, denoed ε. If an ideali pary were eleced, i wold e τ c and ry o pa coniional reform, hence prevening any fre poliician from exracing ren and leading o a high-hman-capial eqilibrim. We hall ame ha wih ome probabiliy v (cloe o zero) i fail in paing coniional reform. Therefore, i i no poible for voer o diingih beween an ideali pary which failed o pa he reform and an opporniic one ha chooe (raegically) o impoe he compeiive ax rae. An hone pary i eleced wih a low probabiliy, ε, hence we foc on he cae in which an opporni pary i in power Reelecion Probabiliie We now rn o he deerminan of he probabiliy of reelecion. The only policy dimenion i wheher or no he pary ha been corrp, and hence, ceeri parib, a voer wold no reelec a pary ha ha been hown o be corrp. In order o relae edcaion o voing behavior, we ame ha edcaed individal can monior he behavior of he pary in power, for example, becae hey are informed abo he co of he pblic good and realize when he compeiive ax level i or i no impoed. The nkilled, on he oher hand, are nable o monior he governmen. We ppoe ha he more edcaed individal here, are he higher he probabiliy ha a corrp pary i cagh, and in pariclar we ame ha he probabiliy of being cagh i L,. 7 A pary ha i proven o be corrp i no reeleced, ince when a new pary i eleced here i a probabiliy ε ha he new governmen i idealiic and e he compeiive ax. If he pary behave honely, i can never be hown o be corrp and i alway reeleced. The reelecion probabiliie a ime can hen be expreed a a fncion of wo facor: he pary behavior a -1 and he nmber of killed individal a. The reelecion probabiliie when he governmen ha been hone or corrp ake he form, repecively, p (, ) = 1, (10a) H L 7 More complex fncion of L cold be ed. A long a hey are increaing or qaliaive rel wold no change.

14 p C ( L, ) 1 L, =. (10b) Recall ha he pary can alo pa coniional reform, which impoe he compeiive ax in all fre ime if i cceed. ccefl coniional reform are correcly oberved by all agen, and he pary ha paed i i reeleced wih cerainy, ha i, p R = 1, L. (10c) The reaon for hi i ha by paing reform he pary ie i hand and make i impoible for hemelve o ax exceively. Thi commimen implie ha voer are cerain ha he ax rae will be he lowe poible. 8 The pary hen ha wo way of increaing he probabiliy of reelecion nex period. One i o be hone in he fir period, forgoing he fir period ren in order o obain a econd mandae. The oher way o increae he reelecion probabiliy i o pa coniional reform, which will enre reelecion whaever he level of edcaion, b will preven he pary from exracing moneary ren in he fre. 4. Pary Behavior and he Dynamic of Edcaion Corrpion, Honey and Reform In order o examine he behavior of he pary in power we have o define hi objecive fncion. We ppoe ha he incmben pary chooe he policy ha maximize he diconed expeced moneary and non-moneary ren received by he pary. I i clear from or dicion above ha an opporniic pary may c raegically e τ over a nmber of period. 9 There are hen hree poible raegie ha we need o conider. The fir one coni in he pary being corrp in all period. Noe ha in hi cae, here will be no change in he nmber of killed individal, i.e. L = L 0 = L, implying ha he moneary ren i he ame in all period. The expeced payoff i given by V ( L C 1 L 1+ δ ) = ( + π ( L )) = ( + π ( L = 0 1+ δ δ + L )), (11a) 8 Thi ampion rle o a world were voer pnih a pary for hi pa behavior. 9 Noe ha a dihone pary cold e a ax rae above τˆ ch ha nobody wan o become killed nex period and hence heir probabiliy of reelecion increae a he co of a lower ren. We rle o hi poibiliy. We may jify i by aming ha here exi an oide opion for killed worker, ay emigraion, which i good enogh o jify edcaion and herefore negaive voe for he pary.

15 where δ i he dicon rae. There are wo effec of he level of edcaion on he payoff from being corrp: a more edcaed labor force increae he moneary ren b alo raie he probabiliy of being cagh. Depending on parameer vale one or he oher effec will dominae, a we will ee below. A econd raegy coni of being corrp in he fir period, geing profi π ( L ) and hen rying o pa reform. hold he reform fail, a new governmen i eleced, The expeced payoff i V 1 (1 + δ ) ) = π ( L ) + + (1 v) + v(1 L ) VCR ( L ) 1 + δ δ, CR ( L which can be expreed a V CR + π ( L ) + (1 v) / δ ( L) = (1 + δ ). (11b) 1+ δ v(1 L) The payoff V CR (L) i ricly increaing in he pply of kill when v i mall. In hi cae, rying o pa coniional reform i almo alway ccefl and herefore almo enre reelecion. Coneqenly, he effec of L on he moneary ren dominae. When hi raegy i choen, corrpion will be hor-lived, and he reform will rel in low axe which wold evenally lead o an increae in killed labor. In oher word, here will be iniional change ha will evenally lead o an edcaion expanion. Noe alo ha hi raegy dominae being hone in all period, which wold have a payoff of ( 1+ δ ) / δ. Alo, a raegy of being corrp for more han one period i no poible in hi infinie horizon model. Thi wold imply ha a all ime he incmben pary wold chooe o be corrp for T period, reling in pervaive corrpion. The hird raegy we need o conider i one in which he pary raegically chooe o indce edcaion expanion. The reaon why he wold chooe o do o i ha by chooing he compeiive ax rae for N-1 period, he enire poplaion wold become edcaed. Thi ha wo effec on he raegie of he pary. Fir, he probabiliy of reelecion of an hone governmen i ch ha he pary remain in power nex period. econd, he increae in he nmber of killed raie op and hence he ren obained a N a compared o hoe a N-1. Noe, however, ha once he oal labor force i edcaed, he probabiliy of a corrp governmen being cagh i 1, hence he pary wold chooe o pa coniional reform a =N. Tha i, he

16 pary wold be hone for N-1 period, corrp a N, and hen pa reform, which wold allow i o remain in power from N+1 onward. The expeced payoff i V π = N 1 ( 1) + (1 v) (1 + δ ) / δ + N i (1 + δ ) i= 0 (1 + δ ) (11c) In hi cae, edcaional expanion will occr fir and iniional reform will follow. The payoff from hi raegy i independen of he level of edcaion. On he one hand, he moneary ren are independen of he crren level of edcaion, a corrpion will occr only when he enire poplaion i edcaed. On he oher hand, he probabiliie of reelecion are no affeced by edcaion eiher, iniially becae hone behavior enre reelecion, and laer on becae coniional reform garanee i Edcaion and he Incenive for Corrpion Prodciviy and Poliical raegie We need o examine in which circmance a pary chooe each of hee hree raegie. There are wo poible cenario depending on he iniial diribion of wealh. The fir i he cae in which wealh ineqaliy i low, i.e. x, 0 i high. The iniial wealh of he nkilled i cloe o he co of edcaion, and inrodcing he compeiive ax wold allow he children of he crrenly nkilled o dy, leading o a killed labor pply of 1 nex period. Alernaively, if iniial wealh ineqaliy i high, ha i x, 0 i low, hen N period of low axe wold be reqired for he nkilled o become edcaed. In hi becion, we ppoe ha ineqaliy i low, ha i, N=1, and examine he effec of prodciviy in he choice of raegy. The nex becion foce on he effec of differen degree of ineqaliy. When ineqaliy i low, biing for ren from (9) give he payoff from he hree poible raegie a 1+ δ VC ( L ) = ( + a(1 + ϕl )) (12a) δ + L V CR + a(1 + ϕl) + (1 v) / δ ( L) = (1 + δ ) (12b) 1+ δ v(1 L) 1+ ϕ ν V = a + 1+ δ (12c) 1+ δ δ 1+ δ

17 The level of edcaion play a crcial role in he choice beween hee raegie. Fir noe ha V i conan for all L, while V CR i increaing and convex in L when v i mall. The payoff from being erly corrp, V C, i increaing and concave if a > a, and decreaing and convex oherwie, where a /( δϕ 1). Tha i, wheher i i increaing or decreaing crcially depend on he kill premim and he ego ren. The poiive effec of edcaion i ha i increae he moneary ren, and hi effec will be ronger he larger he kill premim i, making i more likely ha V C i increaing. The negaive effec i ha i redce he probabiliy of reelecion and implie a lo of ego ren, hence he larger he ego ren,, he more likely i i ha he chedle i decreaing. In wha follow we ppoe ha i no oo large, implying ha he V C chedle i increaing. 10 a > a, i.e. ame ha We hall ame ha he probabiliy of failre v for reform goe o zero. Comparing he hree fncion (ee appendix) we can how ha a L =0 i i he cae ha V CR ( 0) < VC (0) for all parameer, and V C ( 0) < V if and only if A > A, where A i defined in he appendix. Thi implie ha for low vale of edcaion, here are wo poible raegie, eiher V C or V. The former will dominae if nkilled prodciviy i fficienly high. For L =1, we have V C ( 1) < VCR (1) and V V CR 1, ha i, he raegy of being corrp for one period and paing reform will dominae for high level of edcaion. Depending on parameer vale hree poible configraion appear, a depiced in figre 3 and Figre 3 conider he cae of high nkilled prodciviy, ha i A > A. In hi cae, he raegy V i alway dominaed. The iniion for hi i raigh forward: a high level of A implie ha he kill premim A / A i low, and he reling expanion of edcaion cae a mall increae in moneary ren, which i hence alway dominaed. Two viable poliical raegie have o be compared: reform (11b) and fll corrpion (11a). The radeoff faced by a corrp pary i receiving ego ren wih cerainy, or oping for ego and moneary ren wih ncerainy. The vale fncion inerec only once, a he edcaion level 10 The rel obained when he chedle i decreaing are qaliaively imilar. Wha i imporan for or rel i ha V increae more lowly han C V CR 11 There are more poible configraion, a diced in he appendix, b hey amon o he ame choice of raegie are hoe diced here.

18 * L, indicaing ha for economie wih a labor pply maller han * L, he pary i permanenly dihone, ince he probabiliy of being re-eleced i high. For ocieie wih fficienly edcaed poplaion, L > L *, poliician op for coniional reform afer an iniial period of corrpion. The reaon for hi i ha he high level of edcaion implie a low re-elecion probabiliy. The pary hen chooe o commi o low fre axe by paing coniional reform and obain he ego ren from period 2 onward wih probabiliy 1. Figre 3 abo here The alernaive cenario i ha of a high kill premim, ha i A < A. In hi cae, he raegy V alway dominae for low vale of L. The reaon for hi i ha if he compeiive ax rae τ c i choen a, he enire poplaion will be edcaed, +, while eing τ * wold leave he ize of he killed L, 1 = 1 > L, poplaion nchanged. Increaing he killed poplaion ha wo effec on he raegie of poliician. Fir, i raie op and hence he ren obained a +1 a compared o hoe a. econd, he probabiliy of reelecion of a dihone governmen become nll, and hence he governmen will wan o pa coniional reform in he econd period. Thi raegy dominae for low iniial level of L, a in hi cae here i a large increae in he moneary ren compared o wha cold have been obained by being corrp a. There are wo poible cae, depiced in figre 4a and 4b. For inermediae vale of nkilled prodciviy, ha i if A < A < A, where A i defined in he appendix, all hree raegie will be choen a ome poin. Thi i repreened in figre 4a, where we can ee ha for low level of edcaion V will be preferred, for inermediae level he governmen will be erly corrp, while for highly edcaed poplaion V CR will dominae. The cae of low nkilled prodciviy, i.e. A < A, i depiced in figre 4b. A low prodciviy of he nkilled implie ha he ren π ) i low; he lo de o a poiive probabiliy of no being re-eleced i oo ( L, large relaive o he moneary ren and hence he raegy V C i dominaed for all

19 vale of L. If he level of edcaion i low, i.e. L < L ~, he raegy V will be preferred a i i worh waiing one period in order o ge he high moneary ren emming from he increae in he edcaed labor force; for high level of edcaion, V CR dominae a he increae in he moneary ren i no fficien relaive o he dicon facor. Figre 4 abo here We can mmarize hee rel in he following propoiion: Propoiion 2: Poliical Eqilibria and Prodciviy Conider an economy wih low ineqaliy. Then (i) In conrie wih high nkilled prodciviy, here exi a hrehold level of edcaion L * ch ha for L < L * he pary i permanenly corrp while for L L *, he pary implemen coniional reform. (ii) In conrie wih inermediae level of nkilled prodciviy here exi wo ** hrehold level of edcaion, L and L *, ch ha (a) for L L **, he pary engage in edcaion expanion, (b) for L L < ** < * L, he pary i permanenly corrp, (c) for L L *, he pary implemen coniional reform. (iii) In conrie wih low level of nkilled prodciviy here exi a hrehold level of edcaion, L ~, ch ha for L L ~, he pary engage in edcaion expanion while for L > L ~, he pary implemen coniional reform I i clear from or dicion ha an increae in he prodciviy of nkilled worker raie no only naional income, b alo he incenive for corrpion. Thi gge ha he preence of naral reorce or an inernaional ranfer of echnology which i complemenary wih nkilled labor will raie he incenive for corrpion.

20 Ineqaliy and poliical raegie When wealh ineqaliy i high, N period of low axe are needed for he nkilled o accmlae fficien wealh o become edcaed, N being larger he greaer he degree of ineqaliy i. The payoff from being permanenly corrp and from inrodcing coniional reform are nchanged, and ill given by (12a) and (12b). However, he payoff from inrodcing edcaion expanion now depend on he nmber of period of low axe reqired for he nkilled o be able o afford edcaion. For impliciy of expoiion, we le v =0. Then, we can expre he payoff from edcaional expanion a V 1+ ϕ 1+ δ ( N) = a + (12d) N (1 + δ ) δ The effec of higher ineqaliy i o hif down he V chedle, a depiced in figre 5. The conino horizonal line repreen a low level of ineqaliy (low N), and in hi cae we can ee ha perien corrpion never dominae. The dahed line depic an inermediae vale of N, and in hi cae V C dominae for inermediae level of edcaion, while wih high ineqaliy (doed line) he raegy V i never choen. The iniion for hee rel i raigh forward. The more neqal he economy i, he longer i ake o achieve edcaion expanion. ince here i diconing, he preen vale of he moneary ren will be lower he larger N i, and hence V i le likely o dominae. Indeed, when we compare hi expreion o N +1 eqaion (12a), we can ee ha V C ( 0) < V if and only if A δ /( 1+ δ ) > A. Figre 5 abo here From inpecion of figre 5, we have he following propoiion: Propoiion 3: Poliical Eqilibria and Ineqaliy Conider an economy wih a low level of nkilled prodciviy. There exi wo hrehold degree of ineqaliy, N and N, ch ha (i) For low level of ineqaliy, i.e. N < N L and V CR high one., V dominae for low vale of

21 (ii) For inermediae level of ineqaliy, i.e. N < N < N, V dominae for low level of edcaion L L **, V C dominae for L L < ** < * L, and V CR dominae for L > ineqaliy i. * L. The hrehold vale ** L i lower he greaer (iii) For high level of ineqaliy, i.e. N > N, V C dominae for low and inermediae level of edcaion L < * L, and V CR dominae for L > * L. Propoiion 3 indicae ha ineqaliy play an imporan role in he choice of raegy. For a given killed labor force, L, he more neqal he diribion of wealh, he more likely i i ha corrpion prevail The Evolion of Wealh We can now examine he dynamic of wealh nder he hree poible raegie. If he pary i alway dihone, he economy mainain he wo cla diribion wih he ame nmber of killed and nkilled a here were iniially, and heir eady ae wealh will converge o x ( τ * ) < e < x ( τ * ). Op will be low for wo reaon, becae he high ax rae implie a low capial-labor raio, and becae a fracion of he labor force remain nedcaed. If coniional reform i paed a ime, he killed labor force will be nchanged for N-1 period. However, he redcion in he ax rae allow he nkilled dynaie o increae heir beqe, and a N all he labor force will become killed. In hi cae, developmen i foered by poliical reform, wih reform aking place fir and riggering he edcaion expanion. Laly, he governmen may chooe o indce an increae in edcaion a period N ha will hen be followed by iniional reform a N+1. The economy will ecape from he povery rap, b in hi cae, he edcaion expanion occr fir and i hen followed by iniional change. We can mmarize hee rel in he following propoiion: Propoiion 4: Poliical raegie and Long-Rn Developmen Conider he hree poible raegie choen by he pary: (i) If he pary i permanenly corrp he economy remain in a lowedcaion, low-op, high-ineqaliy rap.

22 (ii) (iii) If he pary engage in edcaion expanion, he increae in edcaional aainmen lead o high op and an eqal diribion of wealh. If he pary implemen coniional reform, wealh accmlaion evenally allow he nkilled o acqire edcaion, leading o high op and an eqal diribion of wealh. 5. Dicion and Conclion Propoiion 2, 3 and 4 mmarize he poible paern of developmen (or lack of i) in an economy wih endogeno edcaion and corrpion. Three main rel emerge. The fir one concern he relaionhip beween edcaion and corrpion a he aggregae level. Alhogh we have polaed a poiive relaionhip beween edcaion and poliical knowledge a he individal level, hi doe no ranlae ino a monoonic relaionhip beween he aggregae level of edcaion and poliician behavior. The reaon for hi i he raegic choice of acion by poliician. Edcaion end o increae he ren obained by a corrp pary, b redce he probabiliy of reelecion nex period. When a large fracion of he poplaion i edcaed, he probabiliy of reelecion of a corrp pary i low, which will lead o coniional reform ha in rn impede fre corrpion. The ren effec dominae for inermediae level of edcaion, and in hi cae he economy remain in a lowedcaion, low-income, high-corrpion rap. For low level of edcaion, and if nkilled prodciviy i no oo high, opporni poliician will indce an edcaion expanion ha rel in high-edcaion, high-op and no corrpion. The econd implicaion of or analyi i ha here are wo poible pah o developmen. In one cae, coniional reform redce corrpion and hi evenally lead o edcaion expanion. Tha i, an improvemen in iniion bring abo high edcaion and eqaliy. Alernaively, low axaion rel in a highly edcaed labor force, and hi will in rn preven corrp behavior. Iniion-led developmen i likely o occr in highly edcaed economie, while edcaion-led developmen can only ake place if he prodciviy of he nkilled i low and he diribion of wealh no oo neqal. Laly, we have hown ha conrie wih very low level of edcaion may fare beer in he long-rn han hoe wih inermediae level of edcaion. There are wo circmance nder which he former are likely o ge o of he povery rap. One i he cae of a low prodciviy of he nkilled. Becae prodciviy i low,

23 moneary ren are low. The pary e a low ax rae and indce edcaion expanion, h increaing nex period moneary ren. In doing o, however, he impede corrpion in he fre. Reorce-rich conrie, in which he nkilled have a high prodciviy in he exracion of naral reorce, are hence more likely o remain locked in a high-corrpion/low-edcaion eqilibrim. Thi help explain he empirical evidence, which indicae ha reorce abndance may lead no only o growh rae b alo o poor governance. 12 The oher cenario i he cae of an economy wih a large proporion of nedcaed labor b low wealh ineqaliy. In hi cae, hone behavior one period can allow he enire labor force o become edcaed h increaing he ren obained from corrpion in he econd period. The edcaion expanion, however, mean an increae in he poliical knowledge of he elecorae and rle o corrp behavior for any fre governmen. The cae we have idenified in he model can be illraed wih wo example. Fir, Lain American economie have been, o a large exen, characerized by poor iniion and widepread corrpion. In he mid-20 h cenry hee were economie wih inermediae level of edcaion. Ren were fficienly high o creae he incenive for corrpion, b he level of poliical knowledge of he elecorae wa no high enogh o idenify corrp behavior. A a rel, hee economie were locked in a bad-iniion/low-op/high-ineqaliy eqilibrim. Or econd example concern Ea Aian and b-aharan African economie, which in he mid-20 h cenry, a he end of colonizaion, were boh characerized by exremely low level of edcaional aainmen. In he 1950 he percepion among developmen economi wa ha he erio problem wa faced by Ea Aia. African conrie were reorce rich, and naral reorce wold bring in he revene needed o rigger growh (ee Hance, 1956); Ea Aian economie were nedcaed, reorce poor, and highly poplaed, and hence had no way of ecaping he povery rap. Ye, he nex few decade wineed a maive increae in boh edcaion and per capia income in he Aian economie and agnaion in mo African conrie (Temple, 1999). Or analyi gge a poible explanaion for hee oberved dipariie. A well a poor, Ea Aian conrie were relaively eqal (ee he dicion in Benabo, 1996, and Aghion, Caroli and García-Peñaloa, 12 ee Ble, Damania and Deacon (2005) for empirical evidence, and Robinon, Torvik and Verdier (2005) for an analyi of iniional deerminan of he reorce cre.

24 1999). The model predic edcaion-led developmen, wih an expanion in edcaional aainmen leading o higher op level hogh no necearily o iniional change. Thi i preciely wha ook place in he la decade of he 20 h cenry. In Africa, abndan naral reorce made he prodciviy of he nkilled high, leading o large poenial ren. Corrpion prevailed, impeding edcaion and mainaining low op level. A nmber of qeion remain. The mo imporan one i ha we have emphaized he imporance of he level of prodciviy in an economy in order o deermine he raegy choen by poliician. A more deailed analyi of how prodciviy i affeced by he preence of naral reorce, rade, or inernaional echnology ranfer wold be welcome.

25 Appendix In hi appendix we compare he hree chedle deermining he payoff of parie. Recall ha when N=1, here are hree poible raegie, V C V CR 1+ δ ( L) = ( + a(1 + ϕl)) δ + L + a(1 + ϕl) + (1 v) / δ ( L) = 1+ δ v(1 L) 1+ ϕ ν V = a + 1+ δ 1+ δ δ 1+ δ Fir noe ha V i conan for all L. When v i mall, he fncion V CR v(1+ δ v) i a convex fncion increaing in L, when a > a δ ((1+ δ ) ϕ v(1+ δ ) and ake he + a + (1 v) / δ + a(1 + ϕ) + (1 v) / δ vale V CR ( 0) = and V CR (1) = a L = 0 1+ δ v 1+ δ and L = 1, repecively. Laly, differeniaing he fncion V C we have ' V 0, C > V < 0C a > a δϕ 1 Tha i, he fncion i increaing and concave if a > a, and decreaing and convex oherwie. I ake he vale V C ( 0) = (1 + δ )( + a) / δ and V C ( 1) = + a(1 + ϕ) a L =0 and L =1. In wha follow we ppoe ha a > a. In wha follow we ake v o zero and ame ha hree fncion and he end poin we can how ha V 0) < V (0) CR ( C V < V CR (0) if and only if δ > ϕ V < V C (0) if and only if 1 + δ + 1/ δ > ϕ V C ( 1) < VCR (1) and V < V CR (1) V < V C (1) if and only if 1+ δ a > a 2 δ 1+ ϕ a > a. Comparing he ~ V ~ C ( L) > V = VCR ( L) if and only if a > a~, where ~ 1+ δ ϕ δ a 2 δ (1 + ϕ) ~ and L ( ϕ δ )( ϕ(1 + δ )). Depending on parameer vale, for poible cae emerge: he hree examined in he cae, a well a one obained when δ > ϕ. I can be eaily verified ha in hi cae V alway lie nder he wo oher chedle, and hence he eqilibrim will be eqivalen o ha obained in figre 4. We herefore concenrae on wha happen depending on wheher 1 + δ + 1/ δ > ϕ hold or no. Noe ha if 2

26 1 + δ + 1/ δ > ϕ, hen i alway hold ha a > a~. However, for 1 + δ + 1/ δ < ϕ we m diingih beween he cae a > a~ and ha in which a < a~. In order o be able o beer inerpre hee wo condiion, we can e he fac 2 2 α / ha ϕ = A / A 1 and ( ) ( ) ( 1 α 1 ) 1 / ( 1 ) ( 1 α a = A α α r cφ ), o expre he condiion 1 + δ + 1/ δ > ϕ a δa A > A, (C1) 2 ( 1+ δ ) while a > a~ can be expreed a 2 A A 1+ δ A > A 1. (C2) 1+ δ δ ( ) ( ) ( ) ( ) ( ) 2 2 α / 1 α 1/ 1 α 1 α α r 1 cφ

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