Corruption and firm innovation: a grease or sand in the wheels of commerce? Evidence from lower-middle and upper-middle income economies

The phenomenon of corruption has become topical in contemporary development discourse as it is generally believed that corruption has adverse implications especially in developing countries at both micro and macroeconomic levels. This paper examines the effect of corruption on firm's innovativeness using firm-level data drawn from 33 lower-middle and upper-middle income economies. Four analytical approaches: OLS, 2SLS, Probit and IV Probit estimations were employed to correct for the potential endogeneity in corruption and also allow for the effect of corruption to vary by region and income status. Results show that albeit corruption acts as a sand in the wheels of commerce, its effect on innovation varies significantly across regions and income status: While corruption generally has a negative and significant effect on firm innovativeness, its effect is more intense in lower-middle income countries and Africa. Corruption reduces the likelihood of firm's adoption of innovation such as acquisition of quality ISO certificates, patents and undertaking excellent market research and development, a finding which is more pronounced in the case of lower-middle-income economies and Africa. The main policy implication from this study is the unparalleled trade-off between corruption and institutional quality within the public sector. As a policy recommendation, institutional weaknesses and failures that manifest in the public sector in Asia and Africa need to be urgently tackled so as to reduce corruption and its deleterious effects on firm innovation.