Outward FDI from the USA and host country financial transparency

Abstract

Extant research has focused on the role of host country corruption as either an attractant or deterrent to foreign investment. These studies generally contend that corruption acts more like a ‘grabbing hand’ than as a ‘helping hand’. However, it is plausible that a significant component of foreign investment may be attracted to locales that offer opaque financial environments. Specifically, we hypothesize that money laundering opportunities may encourage illicit capital flows into certain jurisdictions. Using the USA as the ‘source’ country, we investigate the effect of corruption and money laundering opportunities on Foreign Direct Investment (FDI) flows. The empirical findings indicate that corruption deters foreign investment, while money laundering opportunities attract it. We also show that the effect of money laundering and corruption vary based on the host country's level of development. Our findings bolster the contention that FDI into certain host countries is motivated by a facilitation of illicit capital flows.

KEYWORDS:

• Corruption
• foreign direct investment
• money laundering

JEL CLASSIFICATIONS:

• F2
• K40
• R38
• C23

Acknowledgement

The authors would like to thank the anonymous reviewers for their helpful and constructive comments that greatly contributed to improving the final version of the paper. They would also like to thank the Editors for their generous comments and support during the review process.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. The US Foreign Corrupt Practices Act of 1977, for example, prohibits the payment of bribes in foreign countries to assist in obtaining or retaining business, and requires issuers to maintain accurate books and records and have a system of internal controls sufficient to, among other things, provide reasonable assurances that transactions are executed and assets are accessed and accounted for in accordance with management's authorization. The OECD Anti-Bribery Convention of 1997 establishes legally binding standards to criminalize bribery of foreign public officials in international business transactions and provides for a host of related measures that make this effective. Similarly, the OECD's Financial Action Task Force (FATF) is an inter-governmental body established in 1989 to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. In developing countries, national governments, the United Nations, World Bank, and International Monetary Fund have threatened to suspend loans and aid to those countries that are reluctant to fight corruption and money laundering.

2. Specifically, researchers have identified a number of locational advantages including market size, ‘set-up’ expenses (e.g. interest rates and labor costs), and the institutional and political environments within host countries. Other theories of FDI have invoked trade-based gravity models, or have been focused primarily on relative factor endowments (Helpman 1984) or proximity-concentration advantages (e.g. Brainard 1977).

3. Dennis Blair, Director of National Intelligence, ‘Annual Threat Assessment of the US Intelligence Community for the Senate Select Committee on Intelligence,’ Office of the Director of National Intelligence, 2 February 2010, p. 31.

4. The 2002 National Money Laundering Strategy reports that in 2001, US authorities confiscated approximately $386 million and $241 million of money laundering and forfeited assets, respectively. This is much smaller than the estimates of the proceeds available for money laundering from the various crimes mentioned above. The enormous difference between confiscated assets (a few hundred millions) and estimated proceeds available for money laundering (several hundred billions) in the USA illustrates how difficult it is to accurately estimate how much money is laundered in the USA, and whether outward FDI from the USA is a quantitatively important way of moving illicit funds.

5. An exception to the log transformation exists for the (0/1) dummy variables (MLBL, OECD, and FINCRISIS).

6. Baltagi (2005, pp. 136–142) discusses these issues in greater detail.

7. For a more detailed discussion of other channels through which exchange rate movements affect FDI flows, we refer the reader to Froot and Stein (1991).