How corruption influences foreign direct investment: A panel data study

This article analyzes the empirical relationship between foreign direct investment (FDI) and corruption. We study the impact of corruption in a panel of bilateral outward FDI stocks of 21 OECD countries in 59 OECD and non-OECD economies between 1983 and 1999. This enables us to estimate the potential differences of the corruption effects on FDI (a) across countries of different size, development, and remoteness and (b) over the course of years. Empirically, we follow the related literature on international trade and investment and employ a model that explains bilateral stocks of (outward) FDI within the knowledge-capital framework of trade and multinational activity. This empirical setting allows us to isolate the impact of corruption from other determinants of FDI, such as proximity to the market center or factor endowments. Our findings may be summarized as follows. First, we find a negative impact of corruption on FDI, which, in turn, suggests that the helping hand effects of corruption are outweighed by the grabbing hand effects. Second, we demonstrate that corruption is important for intra-OECD FDI but not for extra-OECD FDI. This result indicates that the (observed) growth of FDI in non-OECD economies is driven mainly by economic growth and a change in factor endowments and to a lesser extent by corruption and its underlying grabbing hand and helping hand effects. Third, we demonstrate that the impact of corruption has declined over the years. This suggests that other factors (such as market growth) have become relatively more important than corruption. The remainder of this article is organized as follows. Section II motivates the empirical model and discusses the variables of interest, in particular the measurement of corruption. We also present the econometric specification and the most important estimation issues. Section III discusses the data and presents the empirical results. Section IV concludes. © 2006 by The University of Chicago. All rights reserved.