The Effect of Crime on Foreign Direct Investment: A Multi-Country Panel Data Analysis

Abstract

This paper examines the impact violent crime has on foreign direct investment (FDI) inflows in a global sample of 62 countries over the period 1997 to 2012. Foreign direct investment is considered to be one of those financial flows that help economies, especially developing ones, overcome development challenges. With this end in mind, policymakers in these economies constantly engage in the design of more attractive incentive packages that would ensure their countries become host for many of these potential investments. However, some of these economies may themselves have internal challenges that can either substantially reduce these inflows or completely eliminate them from the pool of potential hosts. One such challenge is the prevalence of criminal activities. Criminal activities have the potential to increase the cost of doing business and can even reduce the demand for goods and services that are sold in high crime areas. Therefore, it is imperative that one should question the impact of crime on foreign direct investment. More precisely, in this paper, we attempt to answer the question of whether or not violent crime acts as a deterrent to foreign direct investment inflows. We use both OLS fixed-effects and generalized method of moments (GMM) specification for our empirical model. Our use of GMM is due to concerns about potential endogeneity between our variable of interest, violent crime, proxied by homicide rates, and FDI. The dynamic panel data method is also useful in addressing issues relating to serial correlation. The results reveal that violent crime acts as a deterrent to FDI. To test the sensitivity of our results, we use a sub-sample of developing countries only. Again, our results reveal a negative effect of crime on FDI. Therefore our result is robust to various specifications. This result has some serious policy implications for countries that struggle to contain violent crime but need foreign direct investment to aid in capital development. In this case, policymakers must address significant crime issues to stem the reduction of foreign capital inflows, especially if these flows are critical to the country's path to sustainable economic development. The literature on the economics of crime suggests a number of initiatives necessary to fight crime. These include but are not limited to reducing income inequality and also increase the level of educational attainments of the populace.