The Impact of Corruption and Transparency on Foreign Direct Investment: An Empirical Analysis (1)

By Zhao, John Hongxin; Kim, Seung H. et al. | Management International Review, January 2003 | Go to article overview

The Impact of Corruption and Transparency on Foreign Direct Investment: An Empirical Analysis (1)


Zhao, John Hongxin, Kim, Seung H., Du, Jianjun, Management International Review


Abstract

* Both corruption and transparency are often perceived to damage the investment environment of a country. However, little research has been undertaken to empirically examine their impacts on foreign direct investments.

* This paper examines the influences of corruption and transparency on the level of foreign direct investment (FDI). Based on a cross-section data of 40 countries in 7 years, statistical results show that the presence of high corruption and low transparency significantly hindered the inflow of FDI to host countries.

* This study (1) contributes explicitly to our knowledge about how corruption and transparency undermine the FDI and (2) presents the practical implications and challenges facing international managers contemplating entering into foreign markets.

Key Results

* Based on a cross-country data of 40 countries in 7 years, the results show that the presence of high corruption and low transparency significantly hindered the inflow of FDI to host countries.

Introduction

Corruption as a cultural, political and economic phenomenon has attracted a lot of public attention around the world in recent years, while the issue of transparency has been viewed with little significance. Transparency often exists in more implicit forms within the purview of government administration, while corruption manifests itself in a variety of forms. Corruption can range from explicit conduct of paying "tips" and "speed money" to implicit ones of favor exchanges and "commissions". In fact, corruption has been so rampant that the Financial Times, in its year-end editorial on December 31, 1995, characterized 1995 as the year of corruption.

The importance of eradicating corruption to ensure a better business environment is widely recognized. In 1997, OECD countries reached a bribery ban agreement that applies to firms headquartered or located in member states (Wall Street Journal September 1997, Hershman 1998). The World Bank and International Monetary Fund threatened to suspend loans and aid to those countries that were reluctant to fight against corruption.

Corruption in general is condemned as a social evil. The phenomenon has led many scholars to search for an array of political, economic and social/cultural factors. Many studies typically attributed the occurrences of corruption to a number of factors including the degree of state intervention in an economy; the degree of governmental discretionary power and monopoly (Alam 1990); intermediation costs; and the wage level of civil servants (Mookherjee/Png 1995, Flatters/ McLeod 1995). However, the scholastic views on its economic impacts have been divergent. The majority of the studies centered on the overall economic impacts of corruption (Mauro 1995). Some argue that corruption converts perfect competition to monopoly and is detrimental to social morale and political stability. Others hold that there is a redeeming value in corruption.

In spite of the growing awareness of the issue, the affect of corruption on the flow of FDI remains primarily anecdotal. Moreover, the issue of transparency of host governments has been relatively ignored in both the public and academic sectors. For these reasons, the question as to how corruption and transparency affect FDI arises naturally. Further segmenting the issue requires consideration of impacts on inward versus outward FDI. For example, less developed countries (LDC)—particularly the emerging economies of East Asia—evidence high levels of corruption. However, until recently, Asian newly emerging economies seemed to experience growth in inflow of foreign direct investment. This leads to a multi-faceted analysis of the relationships between corruption, transparency and FDI.

This analysis uses a sample of 40 countries to establish the empirical evidence on the impacts of corruption and transparency on FDI.

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