UC San Diego

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 worst 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 strong effects of oil windfalls on corruption. On average, a one standard deviation increase in oil royalties produces a 29% increase in corruption. The effects of windfalls on corruption are larger after elections during booms and lower during busts. 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 economic and individual level variables. I show that endogenous entry of worse candidates during booms is likely the cause of these corruption and reelection cycles, as predicted by the theory. Taken together, these results point to a strong effect of oil royalties on local level political equilibria.