Yesterday I claimed that
India is the world’s largest kleptocracy somewhat along
the lines of the claim usually made about India being the
world’s largest democracy (if you use a really flexible
definition of democracy, of course.) One reader, Sudhar, wanted
to know exactly how is it that corruption retards economic
growth. It is a very important question. I could spend a whole
day writing about that but being bone lazy, I am taking the
easy way out of giving you a reference. Why re-invent the wheel,
eh?

So the article you may wish to read is
from the Whirled World Bank
by Paulo Mauro:
Corruption: Causes, Consequences, and Agenda for Further Research.
To quote just a couple of paragraphs:

From economic theory, one would expect corruption to reduce economic growth by lowering incentives to invest (for both domestic and foreign entrepreneurs). In cases where entrepreneurs are asked for bribes before enterprises can be started, or corrupt officials later request shares in the proceeds of their investments, corruption acts as a tax, though one of a particularly pernicious nature, given the need for secrecy and the uncertainty as to whether bribe takers will live up to their part of the bargain. Corruption could also be expected to reduce growth by lowering the quality of public infrastructure and services, decreasing tax revenue, causing talented people to engage in rent-seeking rather than productive activities, and distorting the composition of government expenditure (discussed below). At the same time, there are some theoretical counterarguments. For example, it has been suggested that government employees who are allowed to exact bribes might work harder and that corruption might help entrepreneurs get around bureaucratic impediments.

One specific channel through which corruption may harm economic performance is by distorting the composition of government expenditure. Corrupt politicians may be expected to spend more public resources on those items on which it is easier to exact large bribes and keep them secret–for example, items produced in markets where the degree of competition is low and items whose value is difficult to monitor. Corrupt politicians might therefore be more inclined to spend on fighter aircraft and large-scale investment projects than on textbooks and teachers’ salaries, even though the latter may promote economic growth to a greater extent than the former.

It is a very accessible article and one does not have to be a
genuine economist to gain considerable insight from it.