We analyze the relationship between product market competition and corruption. The existing literature typically views corruption as extortion of “pre-existing” rents. This perspective suggests that competition usually reduces corruption, although generally the sign of this relationship is ambiguous. Shleifer and Vishny (1993), however, show that cost-reducing corruption is promoted by product market competition. That is, the effect of competition on corruption depends of the nature of corruption.Unlike the existing empirical studies that employ cross-country data and general measures of corruption, we test the competition-corruption relationship using firm-level information. Our approach overcomes significant estimation difficulties that resultfrom relying on cross-country data; for instance, we include country fixed effects, and we deal with potential endogeneities by instrumenting competition with US capital-labor ratios for the appropriate industries. Contrary to the existing empirical work, we show that stronger product market competition is associated mostly with greater corruption of the cost-reducing variety.
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