Does Foreign Direct Investment Decrease Corruption?

Abstract

This paper assesses the effect of openness on corruption, using foreign direct investment (FDI) inflows as a measure of openness, after trade intensity is accounted for.We use a broad cross section of countries over the period 1970 to 1994 and address the issue of causality with a new set of instrumental variables relying on geographical and cultural distance between the FDI exporting and recipient countries.The economics literature has demonstrated that higher corruption levels discourage FDI.Here we study the reverse link, that is, how foreign direct investment impacts corruption.We find that FDI as a share of GDP is significantly associated with lower corruption levels, irrespective of import intensity levels.The quantitative impact of FDI on corruption appears to be of the same order of magnitude as that of per capita GDP.