Does corruption matter for FDI inflows? Experiences from Indonesia

Abstract: The effects of corruption have long been debated, but it is only recently that its effect on FDI inflows has been studied. Previous empirical studies have provided scattershot evidence on this effect, with several failing to find any significant relationship with a purely quantitative approach. In contrast, this study seeks to address the impact of corruption on FDI inflows by applying a mixed-method approach, including both a quantitative and a qualitative component. The quantitative study employs a two-way fixed effects panel data model, seeking to statistically determine how corruption affects FDI inflows and whether this effect depends on the main motives for FDI inflows to a certain country. The quantitative study is complemented by a qualitative case study on Indonesia, in order to examine relations and effects that are not possible to detect by a strictly quantitative approach. Our results confirm that the effect of corruption depends on several factors that have not previously been studied in this setting. First of all, the motives for FDI are critical in determining the investors' sensitivity to corruption. Second, the effect of each level of corruption depends on its nature. Third, the profitability of the host market can compensate for the cost of corruption. Forth, the attitude and policies of the investing company determines how it is affected by corruption. Thus, we conclude that corruption indeed has a deterring result, but has no real impact on investments as long as profits are expected to be positive, the costs of corruption included.