The Effects of Host Country Institutions and Corruption on Foreign Direct Investment Flows: Empirical Evidence and Robustness of Indicators

Foreign Direct Investment (FDI) and especially its determinants have been a matter of extensive interest in both academic and policy-making environments during the last decades. Although previous academic literature on the effects of institutions and corruption on FDI has generally been conclusive, showing negative influence of host country corruption and positive effects of institutional soundness on the aggregate FDI inflows, it has been ignoring potential interaction effects between various types of institutional host country characteristics, especially possible trade-off effects between corruption and the regulatory, political and legal institutions. This thesis fills this gap by empirically estimating several variations of the constructed model including a set of control, institutional and corruption variables and their interaction terms. For that purpose, an extensive dataset has been applied, containing 2005-2009 data on the bilateral US FDI flows in 171 countries, along with a large variety of the most recent institutional indicators. The main results provide some support for the existence of positive effects of corruption on FDI inflows in host countries with weaker democratic and regulatory institutions, while in host countries with poor legal investor protection, corruption proves to have a more negative effect on FDI inflows. The findings strongly support the expectation that the relationship between the host country corruption, institutions and foreign direct investment is rather more complex than previous academic literature has been assuming. Additionally, both robustness and explanatory power of various applied institutional indicators have been found to vary considerably while explaining the effects of institutions on FDI. These findings should have consequences for the way the models, which try to investigate the effects of institutions and corruption on foreign direct investment, are specified in the future and underline the importance of global regulation and broad institutional development for combating corruption. Master Thesis