Impact of C orruptio n on Foreign Direct Investment [629330]

Impact of C orruptio n on Foreign Direct Investment
Abstract
The paper investigates the effect of corruption o n foreign direct investment in Pakistan. As in past ,
Pakistan remain very attractive country for the foreign investors. Especially in the telecommunication
and banking sector, there is huge opportunity and attractiveness for the local as well as foreign investors.
The sample covers the level of investment i n Pakistan for the last ten years from different regions of the
world including America, Europe, Asia and Middle East. This paper relates the level of corruption with
the level of F.D.I for the last ten years in Pakistan. As this is a perception that increase in corruption
lowers the level of foreign direct investment. This paper determines whether the foreign direct
investment in Pakistan decreases with the increase in level of corruption or vice versa.
Keywords; corruption , foreign dir ect investment, unit root test, co-integration
INTRODUCTION:
Most developing countries and former centrally planned economies are eager to attract foreign direct
investment (FDI). Hence, understanding the determinants of FDI is important in p ractice as well as in
theory. Moreover, for many countries, a primary benefit of FDI is the inflow of technological know -how
of the foreign investor.
This paper studies two sets of questioning regarding the effect of corruption on the level of foreign direct
investment in Pakistan. First does corruption in Pakistan negatively affect its ability to attract the foreign
direct investment? If yes then by wh ich percentage the corruption affect the level of F.D.I. Pakistan have
number of sectors which can generate high profits for the international investors. Yet the leaders of
Pakistan facing severe problems to convince them to invest in Pakistan. Sectors lik e banking
telecommunication, industrial sector and many others have huge investment opportunities.
From a theoretical perspective, corruption may act as either a grabbing hand or a helping hand for
inward FDI (see Bardhan [1997] and Aidt [2003] for surveys ). While gra bbing hand corruption indicates
that bribery is costly for firms (see Murphy, Shleifer, and Vishny 1991; Shleifer and Vishny 1993;
Boycko, Shleifer, and Vishny 1995), the helping hand view states that corruption ―greases‖ the wheels of
commerc e, especially in the presence of preexisting government failu res (see Lui 1985; Shleifer and
Vishny 1994; Kaufmann and Wei 1999).1 The relative importance of the two aspects determines
whether the overall impact of corruption on FDI is positive or negative , rendering it an empirical
question as to which of the two dominates in Pakistan .
The issue of corruption has become a prominent item on the agenda of international institutions and
national governments.1 The OECD Convention on Combating Bribery of Foreig n Public Officials in
International Business Transactions, which was signed in 1997 and went into effect in February 1999,
criminalizes bribery of foreign officials by firms from member countries. Yet indices produced by
organizations such as Transparency International suggest that corruption is still a widely spread
phenomenon. In this paper, we examine the consequences of corruption on cross -border direct
investment .
RESEARCH PROBLEM STATEMENT
PAKISTAN is facing severe employment problems due to growing population. one of reason among
many others is that of F.D.I not being up to the need of country. Pakistan as an emerging economy needs
very high level of FDI to compete with other e conomies. Low level of FDI can be the result of law and
order situation in the country, political instability, bad governance and many more. But our main purpose
is to evaluate the FDI in Pakistan with the perspective of corruption. so this research will s tudy the
relationship between FDI and corruption.

RESEARCH SIGNIFICANSE
The empirical literature on the effects of the host country‘s corruption level on FDI inflows, however,
has not found the commonly expected effects. Some empirical studies provide evi dence of a negative
link between corruption and FDI inflows, while others fail to find any significant relationship. Most
existing studies use a cross -sectional rather than a panel data analysis to examine the effects of a
complex phenomenon. Such a method cannot control for the unobserved country -specific effects that
may vary across countries and may be correlated with corruption. Even if a panel data analysis is
implemented, those studies have ignored the fact that corruption is not neces sarily an indepe ndent
variable.
LITRATURE REVIEW
The paper investigated the foreign investment attractiveness in Greece. Corruption, defined as abuse of
public power for private benefit, is a global phenomenon that affects almost all aspects of social and
economic life. Examples of corruption include the sale of government proper ty by public officials,
bribery and embezzlement of public funds, patronage and nepotism. The World Bank estimates that over
109 US billion dollars annually are lost due to corruption, representin g
5% of the world GDP . The African Union estimates that due to corruption, the African continent loses
25% of its GDP (Mecshi, 2007)
This article is ba sically about the decline in FDI due to corr uption in country. The relationship between
foreign direct investment (FDI) and government corruption in emerging economies has been largely
debated among researchers, but no definitive conclusion has emerged (Cuervo -Cazurra, 2006 ; Doh,
Rodriguez, Uhlenbruck, Collins, & Ede n, 2003 ; Habib&Zurawicki, 2002 ; Heineman & Heimann, 2006 ;
Henisz, 2000 ; O‘Higgins, 2006 ; Rodriguez, Uhlenbruck, & Eden, 2005 ; Rodriguez, Siegel, Hillman, &
Eden 2006 ; Wei, 2000 ; Wheeler &Mody, 1992 ). For foreign firms operating in emerging economies, an
increase in government corruption creates a further increase in environmental uncertainty. In theory, this
unfavorable change in the environment is a threat to profit and, in the long term, it may threaten the very
presence of foreign firms in the country. (Sethi,2009). This study investigated how MNCs can sway the
growth of financial markets in the developing countries with prevalent political corruption. (Oskooe et
al, 2011)This research article is about the level of corruption in japan and its effect on
FDI.(voyer,2004)This paper investigated the foreign direct investment (FDI) attractiveness
for Greece as a host country compared with the rest of the EU countries.(pentilidis,2007).This article
analyzes the empirical relationship between foreign direct inves tment (FDI) and corruption. (Winner et
al, 2012).This paper studies the effect of corruption on foreign direct investment. (J in wie, 2012) . This
study examined influences on the l evel of corruption in countries
from a strategic perspective.(Andrew et al ,2012).This study is about the relationship between the
government corruption and FDI.(U hlenburk,2012).This paper examined the influences of corruption and
transparency on the level of for eign direct investment (h.kim,2012).This paper studies the impact of
corruption on inward FDI using a unique firm level data set.(J in wie,1997).This study implied the
impact of corruption in the host country on foreign investor preference for a joint venture ver sus a
wholly -owned subsidiary.(S marzynska et al ,2000).
Main objective of this article is to empirically reexamine the effects of corruption on FDI
(Sadiq,2009).Aim of this paper is to find institutional reasons of corruption and its effects on
F.D.I.(hanafi,2008).In a rela ted discussion, it is argued that corruption should not be considered in
isolation as it is strongly correlated w ith the quality of government.(C ole et al,2008)
It has been shown that corruption has adverse effects on economic performance.1 Corruption has a
negative impact on the level of investment and economic growth (Mauro 1995), on the quality of
infrastructure and on the productivity of public investment (Tanzi and Davoodi 1997), on health care and
education services (Gupta, Davoodi, and Tiongson 2000) , and on income inequality (Gupta, Davoodi,

and Alonso -Terme 1998; Li, Xu, and Zou 2000). All those factors are found to be important
determinants of FDI location. Therefore, foreign investors would tend to avoid investing in countries
with high levels of corruption. However, there may exist positive effects of corruption on FDI inflows.
In the presence of a rigid regulation and an inefficient bureaucracy, corruption may increase bureaucratic
efficiency by speeding up the process of decision making (Bardhan 1997). However, this view has been
rejected empirically. Kaufman and Wei (1999) using firm level data covering more than 2,000 firms find
that firms paying more bribes spend more time negotiating with bureaucrats. But two recent studies
show that the effe cts of corruption depend on the country‘s rule of law and economic freedom. Houston
(2007), studying the effects of corruption on a country‘s economic performance, finds that corruption
has positive effects on economic growth in countries with a weak rule of law, while it has negative
effects in countries with sound institutions. Also, Swaleheen and Stansel (2007) find that corruption
enhances economic growth in countries with high economic freedom, while it hinders economic growth
in countries with low eco nomic freedom.
The literature on foreign direct investment (FDI) has evolved in separate theoretical silos and a holistic
conceptualization is yet to emerge. Research has focused mostly on inter -country differences and not
much on explaining intra country FDI variations . Traditionally FDI locations have been evaluated
through country -level FDI determinants even though provinces differ widely in infrastructure and other
attributes. Further, neither is the varying importance of FDI determinants to different i ndustries factored
in, nor are the differing FDI incentives from national and provincial governments integrated into a single
framework. To address these gaps this study synthesizes insights from three streams of FDI research and
develops an integrative co nceptual framework that can comprehensively analyze intra -country
FDI inflows. We demonstrate the usefulness of the framework by empirically analyzing FDI trends
within China‘s 31 provinces. The study thus makes a substantive contribution by offering schol ars,
policy -makers, and practitioners a holistic conceptual and methodological approach for understanding
FDI trends within a country (Deepa.2007) .
This article analyzes the empirical relationship between foreign direct investment (FDI) and corruption.
From a theoretical perspective, corruption may act as either a grabbing hand or a helping hand for
inward FDI , While grabbing hand corruption indicates that b ribery is costly for firms ( Murphy, Shleifer,
and Vishny 1991; Shleifer and Vishny 1993; Boycko, S hleifer, and Vishny 1995), the helping hand view
states that corruption ―greases‖ the wheels of commerce, especially in the presence of preex isting
government failures ( Lui 1985; Shleifer and Vishny 1994; Kaufmann and Wei 1999).1 The relative
importance of the two aspects determines whether the overall impact of corruption on FDI is positive or
negative, rendering it an empirical question as to which of the two dominates .(Peter.2012)
It is a consequence of economic and noneconomic variables and so must be t reated as an endogenous
variable.
Motivated by these issues, the main objective of this article is to empirically reexamine the effects of
corruption on FDI inflows by incorporating an econometric method based on panel data from
PAKISTAN as a host country for ten years starting from 2001 to 2010.
METHADOLOGY:
In this study as its mentioned that corruption is the independent variable. Corruption greatly
influence the rate of F.D.I. we find a negative impact of corruption on FDI, which, in turn, suggests that
the helping hand effects of corruption are outweighed by the grabbing hand effects .(Peter egger 2010 ).
An increase in the corrup tion level from that of Singapore to that of Mexico would have the same
negative effect on inward FD I (Shang -Jinwei 2012) . Corruption has adverse effects on economic
performance.1 Corruption has a negative impact on the level of investment a nd economic growth (Mauro
1995).

Due to the various forms that corruption can take, including practices such as bribery, extortion,
influence, fraud, and embezzlement, corruption has been defined in different ways.
Yet, since we are concerned only with corruption that affects the costs of investment operations, we use
Macrae‘s (1982: 679) definition.
He defines corruption as an ―arrangement‖ that involves ―a private exchange between two parties (the
‗demander‘ and the ‗supplier‘), which (1) has an influence on the allocation of resources either
immediately or in the future, and (2) involves the use or abu se of public or collective r esponsibility for
private ends.‖
The demanders in our case may be the public officials and the suppliers are foreign investors. The debate
on the adverse effects of the level of corruption on FDI inflows has been analyzed in con text of the costs
of doing . The Effects of Corruption‘s . Since foreign investors have to pay extra costs in the form of
bribes in order to get licenses or government permits to conductinvestment, corruption raises the costs of
investment. Such additional costs decrease the expected profitability of investment and so corruption is
generally viewed as a tax on profits (Bardhan 1997).Moreover, corruption increases uncertainty because
corruption agreements are not enforceable in the courts of law. It has been s hown that corruption has
adverse effects on economic performance.1 Corruption has a negative impact on the level of investment
and economic growth (Mauro 1995), on the quality of infrastructure and on the productivity of public
investment (Tanziand Davoodi 1997), on health care and education services (Gupta, Davoodi, and
Tiongson 2000), and on income inequality (Gupta, Davoodi, and Alonso -Terme 1998; Li, Xu, and Zou
2000). All thosefactors are found to be important determinants of FDI location. Therefore, f oreign
investors would tend to avoid investing in countries with high levels of corruption. However, there may
exist positive effects of corruption on FDI inflows. In the presence of a rigid regulation and an inefficient
bureaucracy, corruption may increas e bureaucratic efficiency by speeding up the process of decision
making (Bardhan 1997). However, this view has been rejected empirically. Kaufman and Wei (1999)
using firm level data covering more than 2,000 firms find that firms paying more bribes spend m ore ti me
negotiating with bureaucrats
But two recent studies show that the effects of corruption depend on the country‘s rule of law and
economic freedom. Houston (2007), studying the effects of corruption on a country‘s
economicperformance, finds that co rruption has positive effects on economic growth in countries with a
weak rule of law, while it has negative effects in countries with sound institutions. Also, Swaleheen and
Stansel (2007) find that corruption enhances economic growth in countries with high economic freedom,
while it hinders economic growth in countries with low economic freedom
DATA COLLECTION:
Data for this study have been collected from the website of economic sur vey of Pakistan. All the data is
very authentic and reliable. Data that that has been collected is of year 2001 to 2010.
DATA ANALYSIS:
Variables Types of test
(c, t , n) ADF test
Statistics D-W
Statistics Probability
CPI
FDI C 0 1
C 0 1 -4.117071
-6.892088 1.885651
1.323552 0.0438
0.0042

UNIT ROOT TEST:
The result of the test indicates that all the variables current account balance, export, import, foreign
direct investment, government consumptions, Worker remittance and gross domestic product have a unit
root in their levels and are stationary in their f irst differences. Table -1 shows the results. The test
rejected the null hypothesis that there is a unit root in the first difference of every variable at a 1 %
significant level for variablecurrent account balance, export, Government consumptions, and Wor ker
remittance. And foreign direct investment and imports are the variable at 5 % significant level. While
gross domestic product is at 10 % significant level. The Durbin -Watson statistics also support the value
of each variable as significant.
JOHNSON CO INTEGRATION TEST:
Unrestricted Cointegration Rank Test (Trace)
Hypothesized Trace 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 0.746183 16.52147 15.49471 0.0349
At most 1 0.244976 2.810053 3.841466 0.0937

Trace test indicates 1 cointegratingeqn(s) at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon -Haug -Michelis (1999) p -values

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Hypothesized Max-Eigen 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None 0.746183 13.71142 14.26460 0.0610
At most 1 0.244976 2.810053 3.841466 0.0937

Max-eigenvalue test indicates no cointegration at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon -Haug -Michelis (1999) p -values

CONCLUSION:
The effects of corruption on economic activities have received attention in recent literature. The level of
corruption in the host country has been introduced as one factor among the determinants of FDI location.
Some empirical studies provide evidence of a nega tive relation between corruption and FDI inflows,
while others fail to find such a relationship.
Most existing studies are largely based on a cross -sectional analysis that cannot account for unobserved
country specific effects with which the corruption level is correla ted. In addition, the simultaneity
between corruption and FDI is ignored. This article has sought to answer the following question:
Controlling for other determinants of FDI location, does a corrupt host country receive less or more FDI
inflows?
For this p urpose I have collected data for the last ten years of FDI and CORRUPTION in Pakistan and
the result revealed that corruption have adverse effect on FDI.
The empirical evidence presented in this article can be summarized as follows: The cross -sectional
regressions are consistent with the argument that corruption deters foreign investors.
This study has some limitations. First, FDI inflows can be negative,so the logarithm of FDI may be
problematic because the negative observations would be automat ically drop ped. Excluding those
observations from our sample may bias our results. Another limitation of this study is that it uses
aggregated data on FDI inflows. Foreign investors operating within the same host country may have
different degrees of sensitivity to c hanges in the host co untry‘s corruption level, so one should exami ne
the effects of corruption on FDI inflows based on the nature of di fferent sectors and industries.
Development of sec toral and in dustrial data would prevent potential biases in evaluating the effects of
corruption on FDI inflows.
I believe the potential for futur e research along these lines is warranted.
The empirical evidence presented in this article can be summarizedas follows: The cross -sectional
regressions are consistent with the argu ment that corruption deters foreign investors. However, as we
move to panel data methods, the negative impacts of corruption disappear once we control for the host
country‘s institutional quality, suggesting that foreign investors value the quality of institution s more
than the level of corruption in the location selection .
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