Dundee Discussion Papers in Economics 152: Corruption and competition in the presence of inequality and market imperfections

We analyze the relation between corruption, competition and inequality in a developing economy context where markets are imperfect and there is wealth inequality. We consider an economy where different types of households (potential firms) choose whether to enter production sector or not. The potential firms may be either efficient or inefficient. The credit market is characterised by information asymmetry and wealth inequality. As a result the market fails to screen out the inefficient types. In addition to the imperfect screening in the credit market, the inefficient type’s entry is further facilitated by corruption in the product market. These inefficient types also find it profitable to engage in corruption and their presence in the market leads to a rise in corruption. We analyze the market equilibrium and look at some of the implications. We show that a rise in inequality can lead to an increase in corruption, and greater competition and higher levels of corruption can co-exist.