Corruption and Foreign Direct Investment

Author(s): Mohsin Habib and Leon Zurawicki

Source: Journal of International Business Studies , 2nd Qtr., 2002, Vol. 33, No. 2 (2nd
Qtr., 2002), pp. 291-307
Published by: Published by: Palgrave Macmillan Journals on behalf of Academy of
International Business.

Stable URL: https://www.jstor.org/stable/3069545

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 Corruption and Foreign Direct
Investment

Mohsin Habib*
UNIVERSITY OF MASSACHUSETTS, BOSTON

Leon Zurawicki**
UNIVERSITY OF MASSACHUSETTS, BOSTON

This study examines the impact of ined. The analysis provides support
corruption on foreign direct invest- for the negative impacts of both.
ment (FDI). First, the level of cor- The results suggest that foreign
ruption in the host country is ana- investors generally avoid corrup-
lyzed. Second, the absolute differ- tion because it is considered wrong
ence in the corruption level between and it can create operational in-
the host and home country is exam- efficiencies.

INTRODUCTION ment intervention, barriers to entry and

Since 1986, with the liberalization of competitive climate, are much less so.
the regimes in many FDI recipient coun- The analysis is further complicated, as it
tries, the volume of foreign direct invest- is not clear at what stage of the FDI de-
ment (FDI) has been growing over 20% cision-making process specific variables
annually (WIR, 2001). Even though FDI are considered (Schniederjans, 1999).
is a popular subject in international busi- One factor that has drawn attention
ness literature (see Caves, 1996; and En- lately is corruption in the host countries.
sign, 1996), the recent surge in FDI de- Corruption has gained prominence as
mands new attention. Numerous statisti- the contacts between less corrupt and
cal and econometric analyses addressed corrupt countries intensified in the
more
the spatial distribution of FDI and the last decade. Corruption does not seem to
underlying forces. Modeling FDI isdeter
a FDI in absolute terms. China, Bra-
zil, Thailand and Mexico attract large
complicated task because so many vari-
ables intervene. Among explanatory
flows of FDI despite their perceived high
variables, general economic phenomenacorruption. Within the industrialized
are quantifiable and available. Others,
world, while Italy is perceived relatively
corrupt and receives modest inflows of
like the quality of workforce, govern-

* Mohsin Habib is Assistant Professor of Management at the University of Massach

Boston. His research interests include FDI and ethics in the context of multinationals.

** Leon Zurawicki is Professor of Marketing at the University of Massachusetts, Boston. H

interests focus on competition among multinational corporations and locus of their FDI.
We wish to thank the anonymous referees and the editor for their valuable comments on ear
drafts of this paper.

291
JOURNAL OF INTERNATIONAL BUSINESS STUDIES, 33, 2 (SECOND QUARTER 2002): 291-307

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CORRUPTION AND FDI

FDI, Belgium, which is similarly rated bilities, and the reduction in transaction
on corruption (by Transparency Interna- costs. The third element, location (L) ad-
tional), attracts substantial FDI. Address- vantages, has attracted renewed atten-
ing such a paradox requires careful anal- tion due to (1) changes in the extent,
ysis. So far, scholars in economics and character and geography of MNE activity
public policy have dealt with corruption in the last two decades, and (2) the link-
(Bardhan, 1997). Analogous empirical ages of the spatial aspects of the MNE
research from the international business
value-added activities to firm competi-
perspective is scanty. tiveness (Dunning, 1998). The location
Understanding the pernicious role ofof FDI is driven by the search for (1)
corruption in FDI is important since itmarkets, (2) resources, (3) efficiency, and
produces bottlenecks, heightens uncer-(4) strategic assets (Dunning, 1998). This
tainty, and raises costs. Further, corrup-implies that different location selection
tion creates distortions by providing criteria apply to projects of different mo-
some companies preferential access totivation. Thus, identifying the variables
profitable markets. The difference in theexerting the strongest impact on particu-
exposure to corruption between the host lar types of investment is important.1
and home countries can also be a con- The majority of previous studies have
relied on total FDI inflow data, obscuring
cern for investors. The greater such dif-
ference between the two countries, the the links between specific location char-
lower the likelihood that they know how acteristics and the type of motivation.
to deal mutually. Given a choice be- This study also uses aggregate FDI data,
tween a familiar and a less familiar en-
however, when appropriate, the location
variables relevant to specific FDI orien-
vironment, firms will prefer the former
(Davidson, 1980). tation are highlighted.
This paper adopts a dual approach in Identifying additional variables can
assessing the impact of corruption on expand our knowledge of the (L) advan-
FDI. First, the effect of the level of cor- tages and their influence on FDI. To this
ruption in the host country is investi- end, corruption, a factor that has re-
gated. Second, the effect of the difference ceived attention lately, is included
in the corruption levels between the among the descriptors of the attractive-
home and host countries is examined. ness of a location. Corruption is defined
The paper is organized as follows. Ain various ways. International organiza-
re-
view of corruption and its impact on tions
FDI (UN) and Western governments
equate corruption with "improbity",
are presented first. Based on this review,
hypotheses are developed. Analysis which
and encompasses not only what is il-
results are then reported. Finally, legal,
the but also improper (Malta Confer-
end section discusses the findings ence,
and 1994). The World Bank empha-
their implications. sizes the abuse of public power for pri-
vate benefit (Tanzi, 1998). Whereas
THEORY
corruption of public employees is a dom-
inant theme, Coase (1979) also argues
The OLI paradigm (Dunning, 1988)
that corruption exists between private
provides guidance for FDI activities. The
ownership (0) and internalization (I) parties.
ad- Although corruption can be op-
vantages are derived from the exploita-erationalized as an all-inclusive variable,
comprising bribes, bureaucratic ineffi-
tion of firm-specific resources and capa-

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 MOHSIN HABIB, LEON ZURAWICKI

ciency, and political instability, it is proximations of the economic and polit-

used here to describe bribery in private ical risks of host countries. Foreign in-
and public sectors. vestors may consider corruption morally
Studies have looked into the anteced- wrong and stay away from countries
ents and consequences of corruption for
with high levels of corruption. For exam-
the national economy. Rose-Ackerman ple, a number of African countries where
(1975), Shleifer and Vishny (1993), Mac-
corruption is rampant, the economy poor
rae (1982), and Husted (1994) providedand not growing, receive very little FDI
the theoretical frameworks using public
(WIR, 2001). Honesty has its price, how-
choice, game theory, and transaction- ever, if it means inability to compete in
cost economics. Shleifer and Vishny
some markets.
(1993) argued that in countries with dis- Corruption is widespread in countries
organized corruption, economic growth where the administrative apparatus en-
would suffer. Mauro (1995) linked the joys excessive and discretionary power,
corrupt institutions with the perpetua- and where laws and processes are barely
tion of inefficiency. Gupta, Davoodi and transparent (Tanzi, 1998; LaPalombara,
Alonso-Terme (1998) demonstrated how 1994). Also, lack of economic develop-
corruption impacts economic develop- ment and income inequalities increase
ment and worsens poverty. corruption (Alam, 1995; Macrae, 1982).
Simultaneously, another stream of Corruption inhibits the development of
thought (Leff, 1964; Braguinsky, 1996) fair and efficient markets (Boatright,
holds that in case of rigid egalitarian re- 2000). A corrupt economy does not pro-
gimes, corruption need not deteriorate vide open and equal market access to all
economic performance. In this context, competitors. Price and quality become
bribes "grease" the system and contrib- less important than access, since bribery
ute to Pareto optimality (Rashid, 1981). takes place in secret. Payments to the
However, Kaufmann and Wei (1999) host country officials do not have a mar-
showed that companies that pay more ket value and, hence, raise the cost of
goods when compared to a competitive
bribes waste more time negotiating with
bureaucrats. Hence, because of the greedmarket. This can be a major disincentive
of the corrupt officials the "grease effect"
for foreign investors. Corruption persists
might not materialize (Tanzi, 1998). because some companies can use it to
Beck and Maker (1986) and Lien (1986) advance their own interests. Had each
showed that in bidding competition, the and every investor (local and foreign)
most efficient firms pay the most bribes. resisted corruption, their combined
Lui (1985) suggested that firms placing a power would have eradicated it. That
high value on time offer bribes to make does not happen because a game of "out-
decisions quickly. Thus, corruption en- smarting" others is sometimes played.
hances allocation efficiency. However, Empirical analyses have not yet con-
Tanzi (1998) suggested that those paying sistently confirmed the negative relation-
the highest bribes are not necessarily the ship between corruption and FDI. Hines
most efficient firms but successful rent- (1995) found a non-significant relation-
seekers. ship between the two. Also, Wheeler and
Corruption and FDI have only recently Mody (1992) did not detect a significant
been jointly considered. Previously, cor- negative relationship between FDI and
ruption was incorporated in different ap- the host country risk factor, a composite

VOL. 33, No. 2, SECOND QUARTER, 2002 293

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CORRUPTION AND FDI

measure including corruption. However, under control. Also, the host country's
this result could be affected by the mea- willingness to accept the presence of TI
sure itself since, besides corruption, it chapter sends a positive signal. If, how-
combined twelve other indicators, some ever, corruption is deeply ingrained,
of them marginally important for FDI bringing in TI can help improve the cur-
(Wei, 2000). Drabek and Payne (1999) rent FDI situation but may not do much
tested how FDI was affected by non- to actually combat corruption. Empiri-
transparency, a composite of corruption, cally, the impact of corruption on FDI
unstable economic policies, weak and when a corporate watchdog is present is
poor property rights protection, and poor yet to be determined. Hence, the follow-
governance. Results indicated the nega- ing hypothesis is proposed.
tive impact of high levels of non-trans-
Hypothesis lb: Corruption will con-
parency on FDI.
tinue to have a negative effect on FDI
Other studies identified a negative re-
when TI in the host country is in-
lationship between corruption and FDI.
cluded as an independent variable in
Wei (2000) analyzed data on FDI in the
the analysis.
early 1990s from 12 source countries to
45 host countries. Corruption revealed a It is believed that political stability
significant and negative effect on FDI. positively affects FDI (Kobrin, 1976) and
Busse et al. (1996) looked at the relation- that political stability and corruption are
ship between FDI and the level of cor- negatively correlated (Wei, 2000). Uncer-
ruption exposed by the local media. tain political situations make investors
Reviewing the inconsistent results per- and public officials short-term oriented
taining to different countries, they hy- and pursuing personal gains while sacri-
pothesized that FDI increased when in- ficing the legality. Alternatively, a stable
vestors believed that the government political environment encourages a long-
would curb corruption. Alternatively, term orientation and reduces incentives
FDI would decrease with media expo- for quick illegal returns. In the end,
sure should investors assume that the
whether the dual effects of political sta-
government was unwilling to improve
bility will actually change the FDI-cor-
the environment. This suggestion, how- ruption relationship is an open question.
ever, was not rigorously validated. Given
The following hypothesis is suggested.
the state of the literature, the following
basic hypothesis is proposed first. Hypothesis lc: Corruption will con-
tinue to have a negative effect on FDI
Hypothesis la: Corruption will havewhen
a political stability is included as
negative effect on FDI. an independent variable in the analy-
Various institutions monitor and ex- sis.

pose corruption. International organiza-

tions are better suited to perform this Difference Between Home and
task objectively as the local (corrupt) en- Host Country Corruption
vironment influences them less. Watch-
Levels and FDI

dogs like Transparency International (TI) For a long time, researchers looked at
can serve two purposes: as a deterrent to the order of selection of foreign markets
corrupt officials and as a reassurance to Since Cyert and March (1963), the be-
havioral model attempted to identify th
the investors that the situation is getting

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 MoHSIN HAIB, LEON ZURAWICKI

markets firms enter first and determine and risky commitment among the inter-
how they organize at each stage of devel-national business activities (Johanson
opment within the new market. A deci- and Wiedersheim-Paul, 1975). Two in-
sion to enter a foreign market is a func- fluences of opposing directions can oc-
tion of knowledge and experience, andcur. First, psychic distance can prove a
the selection of a similar market reduces
greater impediment to FDI in a particular
uncertainty (Aharoni, 1966). In the 70's,
country than to other modes of interna-
the Scandinavian authors categorized tional business. Second, applying previ-
the "psychic distance," to assert that ous lessons from exporting and licens-
companies enter markets perceived to being, the international investors may
psychologically closer before consider-bridge their knowledge and experience
ing the remote ones (Johanson and Wied- gap.
ersheim-Paul, 1975; Johanson and In this study, the notion of similarity
Vahlne, 1977, 1990). Two importantthat as- closely resembles the psychic dis-
pects are emphasized: (1) lower leveltanceof idea is adopted. The similarity ap-
uncertainty in psychically close coun- proach is simpler and more clear-cut as
tries (Johanson and Vahlne, 1990), and it does not presuppose managers' level of
(2) psychic closeness facilitating learn-
knowledge about the host country. Cor-
ing about the target countries (Kogutruptand practices represent a component of
Singh, 1988). local business and administrative cus-
Over the years, more studies were un- toms. Inability to handle corruption
dertaken. Some (Davidson, 1980; Nord- makes FDI challenging for companies
strom and Vahlne, 1992) corroborated from less corrupt countries and can re-
the hypothesis that firms expand first to sult in a negative FDI decision. Alterna-
the psychically close and then to the tively, exposure to corruption at home
more psychically remote countries. Yet, provides a learning experience preparing
Benito and Gripsrud (1992) and Engwall the individual companies to handle
and Walenstal (1988) found no support them abroad. Hence, acquiring skills in
for the hypothesis that the first FDIs are managing corruption helps develop a
made in the countries that are culturally certain competitive advantage. This ad-
closer to the home country. Recently, vantage is lost or turned into disadvan-
Ghemawat (2001) suggested that four di- tage when expertise in corruption be-
mensions of distance namely cultural, comes redundant in "clean" markets.
administrative, geographic and eco- While it is easy to comprehend that the
nomic, influence companies considering difference in corruption level between
global expansion. Within this taxonomy, two countries would be more problem-
difference in corruption levels between atic for investors coming from a less cor-
the host and home countries is part of rupt environment than those from a
the administrative distance that creates
more corrupt one, it still constitutes a
significant barriers for foreign investors.
"distance" that both types of investors
To complicate matters further, the psy-
have to overcome. Applying the similar-
chic distance can exert different effects
ity approach to corruption, the following
depending on the mode of firms' in-
hypothesis is proposed.
volvement in international business. To
date, only a handful of psychic distance Hypothesis 2: The greater the absolute
studies addressed FDI, the most serious difference in the corruption levels be-

VOL. 33, No. 2, SECOND QUARTER, 2002 295

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CORRUPTION AND FDI

tween the home and the host coun- ables in the study. In this model, the
tries, the lesser the FDI inflow for dependent
the variable is the log of FDI. FDI
host country. is the annual inflow between the home
and the host country. Log of FDI is used
METHODOLOGY
in the analysis to render the distribu-
tions
The study includes a large number of nearly normal and the error term
host countries offering a broad perspec- homoscedastic. Data on FDI is collected
tive on FDI and corruption. The statistics from the IMF (2000).
on aggregate bilateral FDI flows are ana- The key independent variables are cor-
lyzed in conjunction with key observa- ruption (measured by CPI) and the abso-
tional variables. Most of the data for the lute difference in corruption (Abs. Diff.
sample is derived from the Internationalin CPI) between the host and the home
Monetary Fund (IMF, 2000). The latestcountry. Measuring corruption is prob-
three years with significant country datalematic. There is no consensus among
(1996-1998) are chosen. Altogether, 89researchers regarding what should be
countries are included. These countries measured (Lambsdorff, 1999). Objective
represent the whole spectrum, compris- measures are hardly available because of
ing developed, developing, and the tran- the secrecy of corrupt dealings. Subjec-
sition economies. The selection of the tive measures relying on questionnaire-
home countries: Germany, Italy, Japan, based surveys represent an acceptable al-
Korea, Spain, UK and the USA aims to
ternative for this problem. They measure
provide a fair representation of the
theperception of corruption rather than
Triad, while incorporating countries
corruption per se. Such surveys are com-
piled by organizations like Transparency
with markedly varying levels of Corrup-
International (TI), Political Risk Ser-
tion Perception Index (CPI), a measure
produced by Transparency International and World Economic Forum. In-
vices,
(TI). This is very important, as based terestingly,
on the respective indices are
the methodology applied by TI relatively highly correlated (Tanzi, 1998). In this
small differences in CPI for individual study, the corruption measure collected
by TI (1999) is used. TI, a non-govern-
countries are not statistically significant.
The three-year bilateral FDI data wasmental organization, publishes the Cor-
ruption Perception Index (CPI), which is
pooled together for statistical analysis.
an average of multiple surveys of coun-
Accordingly, a maximum of (7 x 89 x 3)
1869 observations for the variables wastry and business experts. The index
expected. However, a large number of ranks up to 100 countries from the most
missing values related to a country ortoa the least corrupt on a 0 to 10 scale.
year produced fewer total observations.Since its inception in 1995, academics
Two different models are used in this and companies have used the CPI exten-
sively.
study to analyze the effects of corruption
on FDI. The first is an OLS regressionBesides the key independent vari-
model. The second is a PROBIT model, ables, the regression model includes
devised to assess the impact on FDI of"control" variables reflecting the deter-
the absolute differences in corruptionminants of FDI suggested in the litera-
ture. First, variables that affect all FDI
levels between the home and the host
endeavors are included. Second, vari-
countries. The OLS approach is appro-
ables that influence the location of spe-
priate given the use of continuous vari-

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 MOHSIN HABIB, LEON ZURAWICKI

cific types of FDI are highlighted. A brief (Billington, 1999). Under high unem-
discussion of the variables follows. ployment, workers value their current
A classic reason for FDI is the search job higher and are willing to accept
lower wages to keep the jobs. Thus, a
for new markets. FDI is positively influ-
enced by the size of the host economy high unemployment would positively af-
measured by its GDP or population (Ko-fect the resource-seeking FDI. The unem-
brin, 1976). Large markets provide a rea-
ployment data was gathered from the In-
sonable scope for investment and hence ternational Labor Organization (ILO,
influence market-seeking FDI. Log of 2001).
population is our measure of countryStrategic linkage theory (Nohria and
size. Garcia-Pont, 1991) and the network ap-
Host countries' growth rates of GDP proach (Johanson and Mattson, 1988)
seem to be positively related to FDI (Ko- have been presented as other explana-
brin, 1976; Nigh, 1986). High growth en-tions for FDI. Accordingly, FDI serves to
sures demand for the output of the localacquire strategic resources that the firms
market-oriented FDI. GDP growth is in- are lacking. Dunning (1998) and Doz,
cluded in this study. Santos & Williamson (2001) emphasized
GDP/capita is a significant explanatorythe need for most foreign firms to find
variable for FDI (Wells and Wint, 2000; locations supporting innovative activi-
Grosse and Trevino, 1996). High GDP/ ties. Host countries with higher scores
capita reflects high consumption poten- on science and technology will be pre-
tial in the host country. Log of GDP per ferred for asset-seeking FDI. Country rat-
capita is used in this study. ings for science and technology are
Export orientation of the host country adopted for this study from the World
can stimulate FDI (Jun and Singh, 1996). Competitiveness Yearbook (1999).
Countries open to international trade It has been shown that the duration of
provide a good platform for global busi- diplomatic and economic ties between
ness operations. Also, a country's inter- the home and host country increases the
national orientation reflects its competi- likelihood of FDI (Tse, Pan and Au,
tiveness. International orientation of a 1997). Greater business interactions
country is measured as the trade/GDP should promote understanding between
ratio from the IMF (2000) data. the home and host country that is con-
ducive to FDI. Economic ties reflecting
Political stability strongly affects FDI
(Kobrin, 1976). It is considered an imper-
the home and the host country participa-
ative for planning, profitability, andtion in the same common market areas
(EU, NAFTA, ASEAN) or preferential
long-run success. Political Risk Services,
Inc. (2000) publishes Political Risk In-
trade agreements (Lome Convention, Ca-
dex, which is on a scale of 0 to 100, with
ribbean Initiative) are included as a
100 being the most politically stable. The
(dummy) variable in this study. Data was
index is used in this study. collected from the official membership
Labor is another factor importantliststo of the regional blocs.
foreign investors. The more abundant As mentioned earlier, cultural and
(with lower costs) labor is, the more at-
geographic distance affects FDI. Cultural
tractive the location becomes. Country-proximity between the two countries
level unemployment figures have been will facilitate FDI operations. It was cal-
culated applying the Kogut and Singh
considered a proxy for labor availability

VOL. 33, No. 2, SECOND QUARTER, 2002 297

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CORRUPTION AND FDI

(1988) formula to Hofstede's four dimen- Then a categorical variable was devel-
sions of culture. Geographic proximity oped. 0 is assigned if the host country's
exerts a multifaceted impact on FDI, fa- share in global FDI exceeds its share in
cilitating contact with host country and the home country's total outgoing FDI
reducing the transportation costs. Also, (under-investment). 1 applies to cases
in case of large geographic distance, the when the host country's share in global
transportation costs encourage substitu- FDI is equal to or lower than its share in
tion of exports by market-oriented FDI the home country's total FDI (over-in-
(Brainard, 1997). Log of geographic dis- vestment). This categorical variable
tance between the home and the host which focused on relative "under-invest-
countries was calculated from Hen- ment," as opposed to relative "over-in-
geveld (1996). vestment," is subsequently used as a de-
pendent variable in the PROBIT analy-
Finally, the presence of the corporate
watchdogs in the host countrysis, is to
in-estimate the probability that the
cluded as a variable affecting FDI.bilateral
It is FDI flows would fit one or an-
other category as a function of a set of
expected that the presence of organiza-
independent variables. Data on a coun-
tions such as TI will improve the invest-
ment climate. Representation of TI try's
in theshare in global FDI is calculated
from the IMF (2000). Data on the coun-
host country was included as a dummy
variable in the study (TI, 1999). try's share in the total FDI of the home
country
In order to avoid a problem known as is calculated from the OECD
(2000) statistics.
the "omitted variable bias," the regres-
Most of the independent variables
sion model is developed to be as inclu-
sive as possible. All the independent included referred to the same factors as
variables described earlier are included in the OLS regression model.2 How-
in the same model. A test of multicol- ever, since the PROBIT model focuses
linearity among independent variables on the impact of similarities, except for
the geographic distance and economic
using the variance-inflation factor (VIF)
ties, all other independent variables
did not suggest any serious problem.
None of the VIF values exceeded 3. VIF are considered in terms of absolute dif-
values of 5.3 (Hair, Anderson, Tatham ferences between the home and the
and Black, 1992) and 10 (Studenmund, host country levels. It is expected tha
1992) have been suggested as cutoffs for these differences would lead to greate
multicollinearity. Table 1 reports the de- difficulties in operations of foreign
scriptive statistics. firms and, hence, deter FDI. The only
The second (PROBIT) model attempts new variable added is the log of the
to explain the differences between the absolute difference in Gross Capital
host country's share in the global (total) Formation/capita. Like most other vari-
incoming FDI and the same country's ables, it is included to capture as much
share in a specific home country's FDI. as possible the macro environmental
First, the raw differences were calcu- differences between the host and home
lated: countries. GCF data is calculated from
the IMF (2000). Table 2 presents the
Difference in share of FDI = Global
descriptive
Share - Countryi Share, where i denote a statistics for the PROBIT
particular home country of outgoingmodel.
FDI.

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C
o

t TABLE 1
MEANS, ST

Variable Mean s.d. N 1 2 3 4 5 6 7

C) 1. Log population 2.70 1.48 1785

2. GDP Growth 3.65 4.49 1750 -.05*

3. Log GDP/Capita 8.01 1.44 1750 -.12** -..12***

4. Unemployment 7.82 4.09 889 .05 -.07* .02
O 5. Trade/GDP 0.69 0.51 1750 -.35*** .08** .12*** -.15***
t 6. 6Science &
Technology 50.72 14.55 903 -.01 -.09* .62*** -.09' -.03
7. Cultural
Distance 59.74 22.97 1029 -.12*** .02 -.15*** -.20*** .23*** -.08*
8. Political

Stability 72.41 11.71 1582 -.26**" -.07** .78"** -.19**" .31*** .41*** -.05
9. Log Distance 8.11 0.89 1848 .09*** .06* -.25*** -.13*** -.09*** -.14*** .14*** -.27
10. Economic Ties 0.20 0.40 1830 .07** -.05 .31** .11 .07** .12"'* -.17*** .2
11. Corruption
Perceptio
Index (CPI) 4.96 2.45 1491 -.30*** -.03 .868' -.07 .20** .55**
12. Abs. Diff. In
CPI 2.79 1.72 1465 .12**' .01 -.31*** -.00 -.14'** -.17*** .42*** -.

13. LogFDI 4.34 2.45 785 .20*** .02 .23"* -.00 -.06 .22'' -.14'* .1

*p < .05, **p < .01, ***p < .001.

N~~c~ ~ ~ ~ ~ ~~D~~IN
CD
CO

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 o ~~~~~~~~~~~~~~~~~~

MEANs, STANDARD DEvIATIONs, AND CORRxELTIONS FOR

Variable Mean s.d. N 1 2 3 4 5

1. FDI Mode .229 .4205 1283

2. Abs. Diff. In GDP
Growvth 2.298 2.144 1785 -.074**
3. Log Abs. Diff. in
GDP/Capnita 4.071 .3884 1785 -~.214** -.175**
4. Log Abs. Diff. In
GCF/Capita 3.362 .4062 1785 -.111** .209* .512*
5. Abs. Diff. In
Uniemployment 6.276 4.767 747 -.109** -.049 -.019 -.O85*
6. Abs. Diff. In
Trade/GDP 18.599 13.712 879 -.100** -.076* .178** -.115** -.174**
7. Abs. Diff. In
Science & Techn. 23.070 18.402 879 -.039 .005 .261 ** .218* -.108* .416*
8. Abs. Diii. In
Political Stability 11.970 9.571 1562 -~.113** .259** .415 ** .403* -.050 .123*
9. Log- Distance 3.523 0.3190 1764 -~.271** .051* .170** .229* * .049 .247*
10. Economic Ties 0.206 0.405 1758 .431* -.178** -.275** -.248* * -.030** -.193**
11. Abs. Diff. In CPI 2.780 1.722 1431 -~.138** .051 ,335** .142** -.093** .345*

*p <.05, **pK<.01.

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 MOHSIN HABIB, LEON ZURAWICKI

RESULTS p < .001, adjusted R2 = 0.165). This sup-

The OLS regression results for the full ports Hypothesis la.
sample are presented in Table 3. Five Models 3 and 4 are used to test Hypoth-
regression models are run. Model 1 in- eses lb and Ic. Model 3 added political
cludes all the independent variables ex- stability as a variable. As expected, it
shows a significant positive effect on FDI.
cept political stability, TI chapters, CPI,
and absolute difference in CPI. In modelMore importantly, CPI remains a signifi-
cant variable affecting FDI but only at the
1, log of population, log GDP/capita, and
economic ties are significant while p < 0.10 level and the value of its coeffi-
trade/GDP is marginally significant. cient drops from 0.25 to 0.18. Model 4
Hence, consistent with the extant litera- added "TI Chapters" variable that also
ture, country size, consumer purchasing shows a significant positive effect on FDI.
power, open economy, and network of In this model, the CPI variable continues
economies positively affect FDI. The to have a significant, albeit weaker (p <
overall model is statistically significant 0.10), negative effect on FDI (coefficient
and explains 15 percent of the variance drops from 0.25 to 0.18). These results
(F = 9.01, p < .001, adjusted R2 = 0.151). support Hypotheses lb and Ic.
Model 2 introduces the corruption vari- In model 5, the absolute difference in
able, CPI. CPI is significant and nega- CPI is included. The results show that
tively affects FDI (3 = 0.25, p < .05). The difference in CPI negatively affects FDI
standardized coefficient is positive be- (p = - 0.18, p < .001). Also, CPI remains
cause a high CPI means less corruption. significant. The overall model explains
Overall, model 2 is significant (F = 8.97, 20 percent of the variance (adjusted R2 =

TABLE 3
REGRESSION RESULTS FOR THE FULL SAMPLE
(DEPENDENT VARIABLE = LOG FDI)
Variable Model 1 Model 2 Model 3 Model 4 Model 5

Log Population 0.33*** (0.14) 0.43*** (0.16) 0.40*** (0.17) 0.39*** (0.16) 0.44*** (0.16)
GDP Growth 0.01 (0.06) -0.03 (0.06) -0.02 (0.06) -0.04 (0.06) -0.04 (0.06)
Log GDP/Capita 0.22** (0.25) 0.05 (0.31) -0.08 (0.35) 0.14 (0.32) 0.05 (0.31)
Unemployment 0.04 (0.03) 0.07 (0.03) 0.11t (0.03) 0.07 (0.03) 0.06 (0.03)
Trade/GDP 0.11t (0.22) 0.15** (0.22) 0.13* (0.22) 0.11t (0.23) 0.12* (0.22)
Science &
Technology 0.02 (0.01) -0.02 (0.01) 0.04 (0.01) -0.03 (0.01) -0.05 (0.01)
Cultural Distance -0.05 (0.01) -0.06 (0.01) -0.07 (0.01) -0.04 (0.01) 0.02 (0.01)
Log Distance -0.01 (0.15) -0.05 (0.15) -0.07 (0.15) -0.03 (0.16) -0.05 (0.15)
Economic Ties 0.19** (0.31) 0.15* (0.32) 0.13* (0.32) 0.15* (0.32) 0.16** (0.32)
CPI 0.25* (0.11) 0.18t (0.11) 0.18t (0.11) 0.26** (0.11)
Political Stability 0.18* (0.02)
TI Chapters 0.14** (0.30)
Abs. Diff. In CPI -0.18*** (0.09)
Adjusted R2 0.151 0.165 0.173 0.179 0.203
Change in Adj. R2 0.014 0.008 0.006
F 9.01*** 8.97*** 8.68*** 9.00*** 9.48***
N 405 405 405 405 403

Standardized regressio
tp < 0.10, *p < 0.05,

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301

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CORRUPTION AND FDI

0.203). Model 5 supports both Hypothe- was done because it has been suggested
ses la and 2.3 that GDP/capita and political stability
Hypothesis 2 is also tested using the not only affect FDI, but also corruption
PROBIT model. The results are shown in (Wei, 2000; Husted, 1999). In both mod-
Table 4. Model 1 includes all the control els, difference in CPI remains significant
variables, several of which show signifi-and negatively affects FDI. In fact, the
cant results (discussed later). In model 2,significance level increases to p < 0.05
the difference in the CPI variable is in- level when the two variables are ex-

cluded from the regression model

troduced and shows a marginally signif-
(Model 4). Looking at the coefficients
icant negative effect on the share of FDI
of the difference in CPI across models,
flow (3 = -0.09, p < .10). To further test
the robustness of the difference in CPI there is no indication that the effect is
effect, two additional models were run weaker in the presence of two other
without the absolute difference in GDP/ variables. The results support the neg-
ative effect of the difference in CPI on
capita and the absolute difference in po-
litical stability (Models 3 and 4). This
FDI.

TABLE 4
PROBIT ESTIMATON RESULTS FOR FDI
(0 = LESS SHARE OF FDI, 1 = MORE SHARE OF FDI)
Variable Model 1 Model 2 Model 3 Model 4

Constant -0.37 (1.02) -0.37 (1.02) -1.01 (0.86) -0.96 (0.84)

Abs. Difference in GDP
Growth 0.04 (0.05) 0.04 (0.05) 0.04 (0.05) 0.04 (0.05)
Log Abs. Difference in
GDP/Capita -0.31t (0.18) -0.24 (0.19)
Log Abs. Difference in
Gross Capital
Formation per capita 0.41* (0.20) 0.37t (0.20) 0.30t (0.19) 0.31t (0.18)
Abs. Difference in
Unemployment -0.00 (0.02) -0.00 (0.02) -0.00 (0.02) -0.00 (0.02)
Abs. Difference in
Trade/GDP 0.00 (0.01) 0.01+ (0.01) 0.01t (0.01) 0.01+ (0.01)
Abs. Difference in
Science &
Technology 0.01* (0.01) 0.01* (0.01) 0.01* (0.01) 0.01t (0.01)
Abs. Difference in
Political Stability 0.00 (0.01) 0.01 (0.01) 0.01 (0.01)
Log Distance -0.42* (0.19) -0.43* (0.19) -0.42* (0.19) -0.42* (0.19)
Economic Ties 1.19*** (0.18) 1.18*** (0.19) 1.20*** (0.18) 1.19*** (0.18)
Abs. Difference in CPI -0.09t (0.05) -0.10t (0.05) -0.10* (0.05)
,z 109.61*** 110.23*** 108.75*** 110.59***
N 475 471 471 474
Correctly Predicted 73.7% 74.3% 74.1% 74.1%
-2 Log ikelihood 425.35 420.23 421.71 423.75
Pseudo R2 0.300 0.304 0.300 0.303

Standard errors are in parenthesis.

tp < .10, *p < 0.05, **p < 0.01, ***p

302 JOURNAL OF INTER

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 MOHSIN HABIB, LEON ZURAWICKI

Apart from the difference in CPI, tries. This further suggests that foreign
geographic distance and economic ties firms are unwilling to deal with the plan-
show expected significant results in the ning and operational pitfalls related to
PROBIT analysis (negative and positive an environment with a different corrup-
relationships to FDI, respectively). How- tion level. This important fine point is
ever, some unexpected results emerge. worth emphasizing, as it has not yet been
Log of absolute difference in GCF/capita, empirically tested in the literature.
absolute difference in internationaliza- Including corruption in the FDI model
tion, and absolute difference in scienceshould help the companies realize the
and technology all showed positive sig- individual importance of that factor in
nificant relationships to the share of FDI the site selection.4 More importantly, in
(some only marginally significant at the a dynamic business environment, con-
p < 0.10 level). It seems the greater the sidering corruption relative to other di-
difference the higher the FDI flows into mensions will help the managers imple-
the host country. These results require ment complex analyses and refine coun-
further inspection for possible explana- try evaluation procedures. Based on this
tions. study, even small changes in corruption
matter. Thus, once companies determine
DISCUSSION AND CONCLUSION
the importance of corruption for FDI,
This study examined the relationship their response to the expected deteriora-
between corruption and FDI based on tion/improvement in the host country
the recent three-year data. The findings corruption level would have to be pro-
are consistent with the arguments pre- grammed.
sented in the literature and suggest that Foreign investors should take an ag-
corruption is a serious obstacle for in- gressive stance and combat corruption
vestment. The data for this study are ob- for their own long-term interest. For ex-
tained from international statistics onample, if a competitor obtains a license
FDI, aggregated by countries of origin to operate or secures a contract through
and destination. As such, it generalizes
corrupt dealings it is up to the disad-
the individual experiences of thousandsvantaged companies left behind to blow
of investment projects and adds to the ourwhistle. In many national legal sys-
understanding of the pattern of inves- tems, one can render null and void the
tors' reactions to corruption. agreements obtained through corrupt
activities provided convincing proof is
The theoretical arguments against cor-
presented (Malta Conference, 1994). Ex-
ruption derive from both ethics and eco-
nomics. Foreign investors may shun cor-change of information within the busi-
ruption because they believe it is mor-ness community can foster the process.
ally wrong. They may also try to avoid Examples can be found where compa-
corruption because it can be difficult nies
to have made a difference in the way
manage, risky, and costly. The negativethey managed FDI in a relatively "cor-
rupt" country. McDonalds opened its
effect of corruption on FDI found in this
study suggests that firms, as a whole,successful
do outlet in Moscow instilling its
not support corruption. However, in ad-
international standards and making no
dition, the study also found a negative
compromise for the local "corrupt" envi-
ronment. The name McDonald, obvi-
effect due to the difference in corruption
levels between the home and host coun- ously helped maintain a strong stand

VOL. 33, No. 2, SECOND QUARTER, 2002 303

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CORRUPTION AND FDI

against corruption. Another example in- 2. The only omission is the cultural
volving Russia is the 3M Inc., which cap- distance variable. The regression analy-
italized on both the strengths and weak- sis did not find it significant (Table 3).
nesses of the Russian culture positioning Given its correlation with several control
itself as a socially and morally responsi- variables (Table 1), we decided to ex-
ble company. It raised its involvement clude it from further analysis.
with the locals by creating successful 3. As an additional test of the hypoth-
networks but at the same time actively eses, regressions for the FDI samples of
promoted ethical behavior, training its individual home countries are run.
salespeople to avoid illegal acts and per- Apart from CPI and difference in C
sonal harm (Gratchev, 2001). Notwith- variables, fewer control variables are in-
standing such encouraging but infre- cluded so as to accommodate the samp
quently reported initiatives, a continu- size. The majority of the results are co
ing challenge for the companies is how sistent with hypotheses la and 2.
to achieve a unified stance when some 4. Highlighting, for example, that
companies can obtain an unfair advan- change in the level of corruption m
tage through corruption and, in that re- have the same impact on FDI as a chang
spect, outperform their competitors. in the tax rate on earned income.
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