The Impact of Corruption on the Black Market Premium

What is it about?

Recently the impact of institutional factors on macro variables has been gaining momentum. Researchers have investigated the impact of corruption, law and order, and bureaucracy on economic growth, inflation, investment, productivity, and the real exchange rate. In this article, we investigate empirically the impact of institutional factors on the black market premium. In many developing nations, because of government restrictions on capital and trade flows, there exists a black market for foreign exchange. By using data from 60 developing countries over the 1982-1995 period, we show that the black market premium is higher in countries that are plagued by more corruption. This tinding seems to be insensitive to five different measures of corruption as well as whether cross-section or panel data are used.

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Why is it important?

In many countries, especially in developing nations, corruption is a pbenomenon that one cannot avoid. In addition to its social impact, recent studies have investigated the economic impact of corruption. In doing so, researchers have analyzed the impact of corruption on different macro variables, such as growth rate, investment, inflation, productivity, govemment budget, and real exchange rate. In this article we investigate the impact of corruption on the black market premium. Theoretically, we argue that corruption could increase the demand for as well as the supply of foreign exchange in the black market. Thus, it could have a positive or a negative impact on the black market premium. If corruption results in excess demand for foreign currencies in the black market, it increases the premium. Otherwise, it could decrease it. To establish the empirical validity of our new proposition, we borrowed a simple model from the literature and added a measure of corruption as another detenninant of the premium. The model was estimated using cross-sectional data from 60 developing countries for each year beginning with 1982 and ending with 1995. In half the cases we found evidence showing that more corruption results in a higher black market premium. We found more evidence in favor of our hypothesis when we shifted to panel study and estimated the model by pooling data across 60 countries and over the 1982-1995 period.

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