A Second Best Theory of Institutional Quality
- 243 Downloads
This paper illustrates a theory of the second best where the constraints to the achievement of the optimum are of institutional nature. We consider the effects of corruption and bad governance on the public decision to privatize the provision of a service when contracts are incomplete and there is asymmetric information. We show that both corruption and bad governance are detrimental to welfare, but that removing only one of the two is not necessarily beneficial if the other is still present. The theory supplies a possible explanation to the controversial empirical evidence on the economic effects of corruption.
KeywordsCorruption Governance Positive selection Privatization Second best
I wish to thank M. LiCalzi and R. E. Buia for helpful comments.
- Bardhan, P. (1997). Corruption and development: a review of issues. Journal of Economic Literature, 35(3), 1320–1346.Google Scholar
- Boadway, R. (1997). The role of second-best theory in public economics. In B.C. Eaton, & R.G.Harris (Eds.), Trade, technology and economics essays in honour of Richard G. Lipsey (pp. 3–25). Cheltenham: Edward Elgar.Google Scholar
- Laffont, J.-J. (1988). Fundamentals of public economics. Cambridge: The MIT Press.Google Scholar