Corruption distance and FDI flows into Latin America

Abstract

Studies of corruption and its relationship with foreign direct investment (FDI) have yielded mixed results; some have found that corruption deters FDI but others have found the opposite. This paper replicates earlier studies within the OLI paradigm, but also seeks to advance our understanding of this relationship by introducing the concept of “corruption distance” between pairs of countries and applying it to the special context of Latin America.After controlling for transaction costs and institutional variables, results show that corruption distance has an asymmetrical impact on FDI. Host countries with “positive” corruption distance compared to the corruption levels of home countries, experience no significant increases or reductions in levels of inward FDI. However, “negative” corruption distance suffered by host countries is associated with significantly lower levels of inward FDI. We argue that firms from a home country with relatively low levels of corruption are unfamiliar with the formal and informal institutions associated with corruption. Conversely, firms from home countries with high corruption are undeterred by high corruption in host countries. Thus, corruption distance can be seen as a key determinant of FDI when investing in a highly corrupt host location.