EVERY year up to $1.8 trillion in illicit funds derived from corruption, tax evasion and organised crime circle the globe, according to a Transparency International report 2010. The figure is much larger than the funds allocated for the Millennium Development Goals. In another study by Ernst & Young, half of those surveyed estimated that corruption raised project cost by at least 10 per cent.

Apart from the direct monetary losses due to misappropriation of scarce resources, corruption not only distorts markets and creates unfair competition but also weakens institutions by nurturing and sustaining the corrupt government officials and politicians through bribery.

In a similar Ernst & Young survey, almost a fifth of more than 1000 executives claimed to have lost business due to a competitor paying bribes.

However, corruption, which takes advantage of shortcomings in transparency, internal governance and lack of oversight, is not limited to government-led businesses and institutions. Corruption within private enterprises is increasingly becoming an important subject in policy circles, especially after the 2008 recession. It constitutes: executives giving generous payouts to themselves; majority shareholders trying to influence corporate strategy at the cost of long-term profitability; and, staff abusing power entrusted to them for personal gains.

Corruption decreases FDI while FDI decreases corruption: Past studies have spent significant energies in understanding effect of corruption on FDI and mechanism with which such an effect materialises. However, only few have made an attempt to explore the possible effect of FDI on corruption and have found the relationship to be negative and statistically significant. The two main studies in this regard are Pinto and Zhu (2011) and Larrain and Tavares (2004). Larrain and Tavares (2004) use FDI inflows as a measure of openness to access the effect of openness to FDI on corruption after accounting for trade intensity. They find the relation to be significant and negative.

Mechanism of this effect: Due to limited research, the mechanism of how FDI may lower corruption also remains less understood. One way to understand this is to look at the restrictions placed on FDI inflows. With the help of a theoretical model, Krueger (1974) shows how trade restrictions are used ‘as originators of rent’. She emphasises on the role of competition for import licences as an inducement to corruption.

Moreover Ades and DiTella (1999) emphasise high level of corruption in countries where local firms have limited exposure to foreign competition. Deriving inference from trade openness, one may argue that foregoing protectionist policies towards FDI inflows will lower the avenues of corruption exploited by the agents for their individual gains.

Second, FDI itself brings positive spill-over effects through improvement in technology, better management practices and transparency in corporate governance. The increasing role being played by the multinationals in the transfer of technology has been talked about for a long time now.

Findlay (1978) was one of the first few to show this in his ‘explicit analytical model of technological diffusion’. Findlay highlighted the role of major corporations with higher level of efficiency in enabling the less developed countries to better adopt the new technologies. This higher level of efficiency of major corporations further results in the transferring of advanced management skills to domestic firms. In a case study on Russia, Braguinsky and Mityakov (2012) show that domestic firms which interact with foreign corporations in Moscow are twice as transparent as other domestic firms.

Word of Caution: Pinto and Zhu (2011) also discuss the negative consequences of FDI if domestic characteristics are not fully understood. They find FDI to be associated with high levels of corruption in less developed economies and in autocracies. This is mainly due to non-competitive markets, high custom duties (lowering the degree of openness) etc in the less developed economies.

TI report has argued that in the absence of competitive markets, FDI may very well lead to increase in corruption as foreign firms bribe the officials to gain unfair foothold in the host economy. On the bright side, this gives less developed countries a promising starting point: strengthen their competition commissions, gradually lower the custom duties, and move away from protectionist policies.

Policy Implications: As it is not in the benefit for those in power to increase transparency and accountability, increasing demand to fight corruption has often led to a stand-off between governments and people. Under such conditions, FDI as an additional tool can play an important role in a gradual advancement of a country away from corruption. By this I do not mean to say that fighting corruption should be replaced with encouraging FDI rather this mechanism must be used to augment the fight against corruption.

(aj.pirzada@hotmail.com)