Bribes in the Business Cycles

Abstract

Firms in countries with poor enforcement of property rights are often subject to extortions, which impact the business cycle. Unlike taxes, extortions respond endogenously to exogenous shocks, potentially affecting the volatility of investment, consumption, and GDP. In this study I introduce extortions into a real business cycles framework. The model features an intermediary that demands bribes from firms. In steady state, weak property rights induce higher bribes, lower GDP per capita, and lower investment to GDP ratios. Along the business cycle, they reduce the correlation between investment and output, and amplify the volatility of consumption and investment relative to output. I find this to be in line with the data. My framework accounts for the empirical finding that growth policies are usually more successful in countries with strong enforcement of property rights.