Corruption and Capital: the effect of corruption on foreign investment
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Despite the prevalence of anti-corruption policies in major development agencies, the effect of corruption on development remains contested. Theoretically, corruption increases costs and uncertainty for foreign businesses which discourages investment and reduces economic growth, but in countries with rigid bureaucracies bribes expedite interactions with the government and enable businesses to operate more efficiently. Investment rates directly determine economic growth rates. Given that development agencies base funding decisions on anti-corruption policies, understanding the relationship between investment and corruption is critical. Using datasets ranging from 1970 to 2009, I perform an econometric analysis to answer the question, “What is the effect of government corruption on foreign investment?” I replicate the results of Lambsdorff (2003) to establish a negative relationship between net capital flows and corruption as measured by Transparency International using data from 1970-1995. Using a larger sample of countries, I verify that a similar relationship holds from 1990-2009. Transparency International’s index of corruption is not comparable over time. Switching to the World Bank’s index of corruption allows me to exploit variation over time from 1996-2009. After controlling for time and country fixed effects, changes in corruption become insignificant in determining foreign investment. +,20.500.12711/165,The findings of the fixed effects model indicate that corruption is not a statistically significant determinant of foreign investment on average. Further research will evaluate the World Bank’s anti-corruption policies to determine their origins, applications, and practical effectiveness given that corruption does not appear to affect foreign investment.