Fortune or Evil? The Effects of Inward Foreign Direct Investment on Corruption∗

This paper analyzes the relationship between inward foreign direct investment (FDI) and grand corruption. We argue that the effects of FDI on government corruption are conditional on the host country’s underlying economic and political climate. The underlying structure of the economy determines the possibility of extracting rents that could be distributed among foreign investors and the incumbent. Political develop-ment, on the other hand, determines the level of accountability of the incumbent, and creates a check on the incumbent’s ability to appropriate those rents, and the proba-bility of getting caught and sanctioned for engaging in corrupt behavior. Hence, we argue, FDI will be associated with higher corruption levels in political and economic environments with restricted competition. In more competitive political systems with diversified economies, on the other hand, FDI inflows are likely to reduce the ability of the incumbent to engage in corrupt behavior. Assessing the empirical content of our argument presents several technical challenges. First, while inward FDI has the potential to affect corruption levels in the host countries, previous empirical researc