How do foreign firms’ corruption practices affect innovation performance in host countries? Industry-level evidence from transition economies

Abstract

Using data from the Business Environment and Enterprise Performance Survey (BEEPS), this article investigates how foreign firms’ involvement in corruption practices affects the innovation behaviour and performance of their direct competitors in transition economies of Eastern Europe and Central Asia. By unbundling corruption practices into grand and petty corruption transactions, this paper contributes to deepening the analysis of the ‘grease the wheels’ versus the ‘sand the wheels’ effects of corruption on innovation performance. Our empirical results indicate that grand corruption stifles the propensity of firms in the same line of business to conduct R&D activities and to bring new or upgraded products and services to the market, whereas petty corruption of foreign firms tends to foster major innovations in the domestic market. Domestic firms’ involvement in petty corruption appears to be detrimental to innovation efforts and incremental innovation, but not to major innovation.

Keywords:

• Transnational corruption
• R&D
• innovation
• discrete choice model

Acknowledgement

Alexis Habiyaremye wishes to express gratitude to Chijioke Nwosu, Peter Jacobs and Irma Booyens for their comments on an earlier draft of the manuscript. A word of thanks is also owed to four anonymous referees and to the journal editor, whose pertinent comments and suggestions greatly contributed to the polishing of the article. All remaining errors and omissions are the responsibility of the authors.

Notes

1. Grand corruption refers to large-scale corrupt acts involving officials at the highest levels of government and decision making, often in transactions linked, but not limited, to public procurement contracts.

2. The ‘grease-the-wheels’ argument postulates that an inefficient bureaucracy constitutes a major impediment to business transactions so that some ‘speed money’ or ‘grease’ may help ‘get things done’. Proponents of the ‘greasing wheels’ hypothesis argue that corruption facilitates business transactions that would otherwise not take place because of inefficient bureaucracy or complex regulations. The ‘efficient grease’ hypothesis asserts therefore that corruption can improve economic efficiency and that fighting bribery would be counterproductive.

3. Aidt and Dutta (2008) and Aidt (2009) argue that cumbersome regulations can be seen as part of the corruption problem since corrupt government officials are likely to maintain them and oppose reform because of the corruption potential they represent.

4. Moran (2006) points out that anti-corruption laws, such as the US Foreign Corrupt Practices Act (FCPA) or the OECD convention against bribery (1997), do not prohibit facilitation payments to foreign officials, whose purpose is to grease the bureaucracy in order to expedite the acquisition of permits or speed up the process of conducting their business. To circumvent the interdiction of payments to foreign politicians, firms often resort to forming advantageous partnerships with the latter’s friends or relatives. Batzilis (2015) also found no evidence that laws against foreign bribery affect corporate conduct in the host country.

5. This paper does not focus on the effects of a firm’s (domestic or foreign) corruption behaviour on its own innovation activities where both corruption measures and innovation performance would be taken at the firm level. Instead, we aim to explain innovation activities of firms operating in host countries when faced with corruption activities coming from their direct competitors, especially foreign ones, hence the use of industry-level analysis.

6. The first wave of the BEEPS was launched in 1999–2000 and utilised, for instance, by Hellman et al. (2002, 2003). The second and third waves were launched in 2002 and 2005 respectively, and utilised by Brown, Jappelli, and Pagano (2009). Unlike the first three waves, the fourth one has hardly been utilised. However, it is very difficult to use all of them in a panel setting because the periods are unequally spaced, and the sampling design and the variables are different across waves.

7. The EBRD and the World Bank were aware of the potential non-responses or refusals to respond to questions involving sensitive issues such as ‘informal payments’. Therefore, every effort was made to assure respondents that their answers would be treated confidentially. For instance, questions were phrased indirectly regarding ‘informal payments’ made by ‘establishments like this one’, and respondents were assured that responses would be aggregated and not attributable to themselves or their establishments.

8. There is no loss of generality in assuming a zero threshold in lieu of any threshold, say c, as long as the R&D equation includes an intercept.

9. The estimates for sector categories and country groups are not reported in order to save space. They can be obtained upon request.