Corruption as Insurance: Investment and Political Risk in China

Political corruption is largely seen as producing a deadweight loss for the societies in which it takes place. Countries with high levels of corruption, accordingly, should not be economically successful. China is an important exception. I argue that corruption in China modifies the ideological incentives of elites to abandon pro-market policies and thereby reduces the political risks borne by private investors. I explore this explanation using a formal principal-agent model in which an investor offers a bribe to an official who may decline or accept with the quid pro quo of providing the investor with some political-economic service. The investor’s expected long-term returns and the official’s chance of detection are conditioned on the level of corruption in the society. In light of the comparative statics derived from the model, I explore different kinds of corruption (one-time payment, silent partner, etc.) and examine the explanation empirically.