Foreign direct investment, corruption and democracy

Abstract

This paper studies how factors such as corruption perception and the level of democracy influence foreign direct investment to developing economies. Our results suggest that less corrupt countries and less democratic countries receive more foreign direct investment. What could account for this pattern of investment?This paper is the first to show that perceptions of corruption are highly correlated with indices of economic freedom, but uncorrelated with indices of political freedom. Hence less corrupt countries which provide the right kind of economic environment for investors, such as personal property protection, the right to move capital in and out of the country, or the ability to trade openly in world markets receive more FDI flows. At the same time, while democratic countries ensure provision of political and civil rights for citizens, these are not an automatic guarantee of economic freedoms. In fact, the correlation between the democracy index and these indices of economic freedom is surprisingly low. Hence more democratic countries may receive less FDI flows if economic freedoms are not guaranteed. There could be at least two explanations for why this may happen. First, democratizing developing economies are often unable to push through the kind of economic reforms that investors desire due to the presence of competing political interests. For instance, in some countries such as India, foreign capital is viewed by certain sections as being antagonistic to the interests of the poor and working classes. Hence liberalization measures often meet strong opposition from these groups. This is corroborated by the significant negative coefficient on left-leaning democracies in our regression equation. Second, our sample includes several countries in East Asia and South America that underwent major financial crises in the 1990s. Our results could partly be driven by the inability of these countries to liberalize economically and attract foreign capital subsequent to these crises. Hence the negative coefficient on democracy needs to be interpreted with caution. Democratization could encourage capital inflows provided political freedoms go hand in hand with economic freedoms. Our results might help explain why countries like China and Singapore that rank poorly on the democracy index but are relatively high on the property rights index (and in the case of Singapore, on the capital mobility index as well), do well in terms of FDI inflows.Our results also suggest that there is a diversion of FDI towards countries that are perceived to be less corrupt along these dimensions away from more corrupt countries. For instance, an improvement in the relative level of (perceived) corruption in China could (ceteris paribus) have adverse consequences for other countries in the South Asian region.Further, we find that former and current communist countries that started out with inefficiently high capital-output ratios due to heavy state-led industrialization may attract more inflows as they attempt to substitute 'efficient' forei...

Institutions and Investment in the South and East Asia and Pacific Region: Evidence from Meta-Analysis

“…This suggests that foreign investors view corruption as an extra cost of operation rather than viewing it as helping hand. My results are not in line with the literature arguing that corruption is good for foreign investors (Gastanaga et al, 1998;Globerman and Shapiro, 2002a;Teksoz, 2004;Voyer and Beamish, 2004;Khamfula, 2007;Mathur and Singh, 2013). Negative effects inform us that investors prefer not to invest in countries with high corruption or where there is a lack of anti-enforcement laws.…”

“…However, corruption cannot be considered in isolation from other governance related factors as bad governance is closely associated with corruption. Studies by Gastanaga et al (1998), Globerman and Shapiro (2002a), Hsiao and Shen (2003), Anghel (2004), Gani (2007), Jadhav (2012), Habib and Zurawicki (2001), Wei (2000), Teksoz (2004), Voyer and Beamish (2004), Straub (2005), Dahlstrom and Johnson (2007), Khamfula (2007), Sadig (2009), Mathur and Singh (2013), Woo andHeo (2009), Goodspeed et al (2010), Gordon et al (2012) and Jensen (2003) have focused on the effect of corruption on inward FDI.…”

“…Empirical studies on the measures of governance and inward FDI for the South and East Asia and Pacific region that have been identified in the search are: Gastanaga et al (1998), Globerman and Shapiro (2002a), Globerman and Shapiro (2002b), Hsiao and Shen (2003), Anghel (2004), Globerman and Shapiro (2004), Gani (2007), Hur et al (2007), Adeoye (2009), Brunetti andWeder (1998), Wernick et al (2009), Ali et al (2010, He et al (2011), Muhammad et al (2011), Jadhav (2012, Luca and Spatafora (2012), Habib and Zurawicki (2001), Wei (2000), Teksoz (2004), Voyer and Beamish (2004), Straub (2005), Dahlstrom and Johnson (2007), Khamfula (2007), Brouthers et al(2008), Cole et al(2009), Sadig (2009), Woo and Heo (2009),Qian et al(2012 and Mathur and Singh (2013), Nigh and Schollhammer (1987), Singh and Jun (1995), Busse and Hefeker (2005), Baek andQian (2011), Zheng (2011) and Driffield et al (2012), Seyoum (1996), Lee and Mansfield (1996), Ahn et al(1998), Li and Resnick (2003), Nunnenkamp and Spatz (2004), Ahlquist (2008),...…”

Free Market Institutions and FDI Performance in Emerging Asian Economies

“…Finally, although institutions are generally considered to be important, there is also evidence that instead of general institutional quality and democratic institutions, MNCs appear to be more concerned with a host-country's institutional framework related specifically to the domestic free-market system and the degree of economic freedom Mathur and Singh [2013].…”

Expropriation risk and FDI in developing countries: Does return of capital dominate return on capital?

“…Some authors choose to model FDI in levels without rescaling, as in Egger and Winner (2005), Jensen (2003) and Li and Resnick (2003). Others specify the dependent variable as the natural log of FDI (or closely related transformations), as in Busse (2004), Globerman and Shapiro (2002), Habib and Zurawicki (2002), Mathur and Singh (2013) and Yang (2007), as well as the analysis of bilateral flows using gravity models in Bénassy-Quéré et al (2007), Daude and Stein (2007) and Wei (2000). When estimating the determinants of unscaled aggregate FDI inflows using cross-country data, it is, of course, essential to control for country size by including a measure of aggregate economic activity or population (or both) among the explanatory variables.…”