How Does Corruption Influence the Effect of Foreign Direct Investment on Economic Growth?

Abstract

We investigate the effect of Foreign Direct Investment (FDI) on economic growth by employing the data of 132 countries for the period from 1995 to 2008, considering the role of corruption in each country as an absorptive factor. The estimation results indicate that, although FDI alone does not promote economic growth, it has a significant effect on economic growth if the interaction term between FDI and corruption is considered. The threshold level of corruption separating the negative and positive effects of FDI on economic growth is approximately in the 10th percentile from the least corrupt countries. The existence of a corruption threshold implies a counter-intuitive proposition: that FDI inhibits economic growth in countries where corruption is below a corruption threshold, and promotes economic growth in countries where corruption is above the threshold. Our results are robust even if we use different corruption indices and conduct the instrumental variable estimation to address endogeneity problems.

The role of external debt in the foreign direct investment–growth relationship

“…As noted above, several studies (e.g., Alfaro et al, 2004;Borensztein et al, 1998;Okada & Samreth, 2014) have used interaction terms in regression models to determine the existence of threshold effects and thus the role for spillover effects in the FDI-growth link. However, as emphasized by Girma (2005), Azman-Saini, Law, and Ahmad (2010), and Slesman et al (2015), this modelling strategy has the drawback of imposing the a priori restriction that spillovers are monotonically increasing (or decreasing) with absorptive capacity.…”

“…Okada and Samreth (2014) consider the influence of corruption in the estimation of the FDI-growth regression using an interaction model and find that the threshold is around the 10th percentile of the least corrupt countries in their large sample of 130 countries over the period 1995-2008. Taking economic freedom as a threshold, Azman-Saini, Baharumshah, and Law (2010) use system generalized method of moments estimation with interaction effects in cross-country growth regressions for 85 countries over the period 1976-2004.…”

“…Borensztein, De Gregorio, and Lee (1998) emphasize that only countries meeting a minimum level of human capital can benefit from FDI-led growth gains. Other studies suggest that variables such as financial market development, economic freedom, and corruption could also constitute threshold factors affecting the FDIgrowth nexus (see, among others, Alfaro et al, 2004;Azman-Saini, Baharumshah, & Law, 2010, Azman-Saini, Law, & Ahmad, 2010Hermes & Lensink, 2003;Okada & Samreth, 2014). Countries that fall below the identified threshold level of institutional quality record either negative or insignificant effects.…”

“…Countries that fall below the identified threshold level of institutional quality record either negative or insignificant effects. Other studies suggest that variables such as financial market development, economic freedom, and corruption could also constitute threshold factors affecting the FDIgrowth nexus (see, among others, Alfaro et al, 2004;Azman-Saini, Baharumshah, & Law, 2010, Azman-Saini, Law, & Ahmad, 2010Hermes & Lensink, 2003;Okada & Samreth, 2014).…”

FDI of Vietnam; Two-Way Linkages between FDI and GDP, Competition among Provinces and Effects of Laws

“…By investigating the effect of FDI on economic growth by employing the data of 132 countries for the period from 1995 to 2008. [20] found that although FDI alone does not promote economic growth, it has asignificant effect on economic growth if the interactionterm between FDI and corruption is considered. [21] examines the long-run impact of FDI and trade on economic growth in Ghana.…”