The Effect of Oil Windfalls on Corruption in Brazil

• In Event: The Causes, Costs, and Pursuit of Corruption in Latin America

Abstract

Oil royalties provide a substantial and volatile inflow of non tax-payer money to municipal coffers, creating dynamic incentives for politicians in office. Resource windfalls change politicians’ budget constraints, generate difficulties for voters to distinguish politicians’ integrity, and create incentives for corruptible candidates to enter politics, changing the pool of candidates. Using a formal model with moral hazard and adverse selection, I show how resource windfalls generate the endogenous entry of worse candidates into politics, which generates cycles in corruption and reelection patterns. In Brazil, where offshore royalties are determined and allocated exogenously, oil inflows create strong opportunities for corruption. I find that a one standard deviation increase in oil royalties produces about a 50% increase in the percentage of funds being used in corrupt ways. Furthermore, oil royalties lead to a reelection cycle: when the price of oil is expected to be higher, incumbents are reelected more often than when the price of oil is expected to fall, independent of other economic variables. Taken together, these results point to a strong effect of oil royalties on local level political equilibria.

Author

• Kathryn Baragwanath