Far from home: do foreign investors import higher standards of governance in transition economies?

This paper argues that while a number of recent studies have shown that corruption inhibits foreign direct investment (FDI), comparatively little attention has been given to the behavior of those who have invested in corrupt countries. The authors pose the question: 'do foreign investors in transition countries import better standards of corporate conduct and governance or do they contribute to the problem?'In attempting to answer this question the authors use the Business Environment and Enterprise Performance Survey (BEEPS), a comprehensive survey of over 4000 firms in 22 transition countries. The BEEPS data unbundles the concept of corruption to distinguish and measure different types of corrupt transactions, as well as providing detailed information on the characteristics and performance of firms. This allows the development of a detailed and nuanced picture of the types of corruption that different sorts of firms engage in and the impact of such corruption on firm performance.The main findings of the paper are:While corruption reduces the quantity of FDI flows into the transition economies, it also appears on average to attract lower quality investors with regard to some important governance standards. In particular, in countries where the state is highly susceptible to capture by economic vested interests, FDI firms are significantly more likely than their domestic counterparts to engage in corrupt forms of political influence, a phenomenon that the authors refer to as 'state capture'.By contrast, in countries that have avoided the trap of significant state capture by vested interests, FDI firms are significantly less likely than their domestic counterparts to engage in corrupt forms of political influence Different types of foreign investors engage in particular types of corruption tailored to their comparative advantages. FDI firms with local partners are more likely to engage in state capture. Larger multinational firms with headquarters overseas rely much less on state capture, yet are much more likely to resort to illicit private payments to public officials to secure public procurement contractsThe evidence does not support the view that foreign investors are coerced to pay bribes despite common claims to the contrary. In fact the direct performance gains to foreign investors from these forms of corruption are shown to be considerable. In addition, foreign firms pay no more in bribes than their domestic counterpartsOn the basis of this survey evidence collected in 1999-2000, transnational legal restrictions to prevent bribery, such as the US Foreign Corrupt Practices Act and the much more recent OECD Convention on Bribery of Foreign Public Officials, have not led to higher standards of corporate conduct among foreign investors bound by their provisions, though the OECD Convention is still in the very early stages of implementation.The authors argue that these findings should not be read as a case against foreign investment. Indeed state capture is created and maintained through restrictions on competition and entry in strategic sectors. Encouraging greater competition in the economy is essential in creating a more competitive market for influence, which should place constraints on the ability of any small group of actors to capture the state.