Research Question: How does a country’s openness to foreign investment impact corruption? Do protected industries in emerging markets encourage the use of bribes?
Preparer: Damaris Colhoun
According to a New York Times investigative report, between 2002 and 2005, Walmart paid more than $24 million in bribes to Mexican officials, obtaining, in days, permits that typically took months to process. Similar transgressions by the multinational retail giant were found in Brazil, India, and China. And Walmart is not alone. Siemens AG and GlaxoSmithKline have also been cited in high-profile bribery cases. This pattern of corruption in emerging markets is in stark contrast to prevailing research, which suggests foreign investment reduces incentives to bribe. The authors of this study believe there is a good reason for this discrepancy: the research is too “broad-brush,” relying heavily on data aggregated from total foreign investment entering an economy, and as a result, fails to isolate the actual cause of corruption. To demonstrate their point, researchers turned to Vietnam, an illuminating test case for three reasons: its communist past and relatively recent, incomplete liberalization; its high rate of reported corruption; and, the bilateral trade agreements it signed in 2000 and 2006. These agreements–the first with the United States and the second with the World Trade Organization–were not implemented uniformly: some sectors remained closed entirely to foreign firms while others required special approval from the prime minister’s office, known as “Group A” projects. According to Vietnam’s Common Investment Law, Group A restrictions applied to all sectors that have an impact on national defense, security, social order, safety, and public health. These sectors are dominated by state-owned enterprises and, not coincidentally, offer greater potential gain, with fewer enterprises competing and profit margins 13% higher than unrestricted sectors. This promise of profitability theoretically incentivizes foreign enterprises to “pay for the privilege.” It also gave researchers an opportunity: by comparing the registration activity of domestic and foreign firms in both restricted and unrestricted sectors, they could get past abstract perceptions of corruption and track actual behavior in paying bribes.
To test their theory, researchers employed original, firm-level survey experiments, conducted annually for three years starting in 2010. More than 19,000 domestic firms and nearly 4,000 foreign investment enterprises were contacted, all of which had registered after 2000. These firms were randomly divided into two groups: those who’d receive “form A” and those who’d receive “form B”. Both forms contained a list of four common activities related to business registration– “Hired a local consulting/law firm to obtain the license…” being one example. But only “form B” contained an activity related to bribery: “Paid informal charge to expedite procedures.” The interviewer and researcher were not aware which form a specific firm received and the firm was only asked to identify the number of activities they participated in. As a result, respondents could reveal critical information without fear, removing the threat of firms lying in order to avoid incriminating themselves.
Consistent with researchers’ hypothesis, there is very little difference between the bribe activity of foreign and domestic firms in unrestricted sectors, with 18% of foreign firms and 21% of domestic firms answering “yes” to the form B “informal charge” question. Group A projects, however, told a very different story. Domestic firms paid bribes at roughly the same rate in restricted sectors as they did in unrestricted sectors, an unsurprising result considering that most restricted sectors in the analysis were completely open to domestic investment. On the other hand, foreign enterprises required to go through the prime minister’s office paid bribes 48% of the time, a shockingly high rate.
This study demonstrates that corruption, like other business activities, is nuanced, a two-way street where behavior is dictated by expected gains by both parties: foreign enterprises and the officials they bribe. It is not simply an additional tax on doing business. Vietnam incentivizes foreign investors to pay for the privilege of doing business in the nation’s most profitable sectors. By removing restrictions, the value of bribing would be reduced. The overall registration bribe rate in Vietnam is 19.4%. Researchers estimate that if the government removed all remaining restrictions on foreign investment, that rate would fall to 16.6%. Vietnam resembles many other liberalizing economies that have state owned enterprises operating alongside private domestic and foreign companies. By instituting entry restrictions to help cultivate state businesses, they have also encouraged foreign enterprises to bribe their way into guaranteed profits.