Corruption Distance and Foreign Direct Investment

Abstract

We study the effects of “corruption distance,” defined as the difference in corruption levels between country pairs, on bilateral foreign direct investment (FDI). Using a “gravity” model and the Heckman (1979) two-stage framework on a data set of 45 countries from 1997 to 2007, we find that corruption distance adversely affects the volume of FDI to be invested in a host country. However, we do not find statistical evidence that corruption distance influences FDI’s decision on whether to invest or not. The volume reduction effect of corruption distance varies across different source-host-country-pair samples. Further, we identify the asymmetric effect of corruption distance and find that the positive corruption distance, defined as the corruption distance from a high corruption source to a low corruption host country, is the prominent one that affects the behavior of bilateral FDI. Again, the degree of such asymmetric effect varies across different country-pair samples.

Keywords: foreign direct investment, corruption, developing countries

JEL Classification: F21, F23, F59, O5