. Broadman and Francesca Recanatini The World Bank Europe and Central Asia Regional Operations Poverty Reduction and Economic Management Department

findings Ten years into the transition process, corruption is now recognized to be a pervasive phenomenon that can seriously jeopardize the best intentioned reform efforts. Because of the complex and deep political economy dynamics surrounding the process transition economies are undergoing it is essential for policy-makers to understand the causes of corruption. This paper develops an analytical framework for examining the role basic market institutions play as determinants of rent-seeking and illicit behavior in transition economies. Using data only recently available on the incidence of corruption and institutional development in such economies, we provide some preliminary evidence on the linkage between the development of market institutions and incentives for corruption. In addition, we explore the relative roles of different market institutions on corruption. Utilizing various indicators for different dimensions of market institutions in transition economies based on our analytical framework, and after controlling for other factors that may affect corruption suggested in the literature, we find empirically that these institutional indicators are systemically associated with the incidence of corruption in a broad set of transition economies. While virtually all of the indicators we examine appear to be important, three emerge as especially statistically significant: the intensity of barriers to new business entry, the effectiveness of the legal system and the efficacy and competitiveness of services provided by infrastructure monopolies. The main lesson from our analysis is that a well-established system of market institutions—one characterized by clear and transparent rules, fully functioning checks and balances, including strong enforcement mechanisms, and a robust competitive environment—reduces rent-seeking opportunities and, in turn, the incentives for corruption. Our empirical investigation points to the importance of both the design and effective implementation of such measures to promote the establishment of an effective market system; in other words, it is not enough, for example, to simply enact first class laws if they are not enforced. In this regard, the dynamics engendered by the tensions in a country's political economy regime play a crucial role in determining the extent to which implementation of a given policy reform will be successful in curtailing corruption. Indeed, throughout our analysis we emphasize the importance of political economy factors—the credibility and commitment of government to carry out announced reforms, the degree to which government officials are captured by the entities they regulate/oversee, the stability of the government itself, and the political power of entrenched vested interests. These factors have long been recognized …