Quality of Bureaucracy and Open-Economy Macro Policies

Abstract

Bureaucratic quality in terms of the level of corruption varies widely across countries, and is in general slow to evolve relative to the speed with which many economic policies can be implemented such as the imposition of capital controls. In this paper, we study the possibility that quality of bureaucracy may be an important structural determinant of open-economy macropolicies, in particular, the imposition/removal of capital controls and financial repression. We first derive a model that delivers such a result. Bureaucratic corruption translates into reduced ability by the government to collect tax revenue. Even if capital control/financial repression is otherwise inefficient, as long as the government needs the revenue for public goods provision, it would have to rely more on capital control/financial repression. For all countries for which we can obtain relevant data, we find that more corrupt countries are indeed more likely to impose capital controls, a pattern consistent with the model’s prediction. The result of this paper suggests that a premature removal of capital controls mandated by outside institutions could reduce rather than enhance economic efficiency.