Draft for discussion and comments Far From Home: Do Foreign Investors Import Higher Standards of Governance in Transition Economies?

Based on the Business Environment and Enterprise Performance Survey (BEEPS) of firms in transition countries, which unbundles corruption to measure different types of corrupt transactions and provide detailed information on the characteristics and performance of firms, we find that: i) corruption reduces FDI inflows and attracts lower quality investment in terms of governance standards; ii) in misgoverned settings, FDI firms may magnify the problems of state capture and procurement kickbacks, while paying a lower overall bribe burden than domestic firms; iii) FDI firms undertake those forms of corruption that suit their comparative advantages, generating substantial gains for them and challenging the premise that they are coerced, which makes it difficult to develop effective constraints on such behavior; and, iv) transnational legal restrictions to prevent bribery had not led to higher standards of corporate conduct among foreign investors by the year 2000. Rather than being construed as a case against foreign investment; we argue that state capture is created and maintained through restrictions on competition and entry in strategic sectors. Thus, enhancing competition by attracting a wider, more diverse set of FDI firms is critical to the broader strategic framework of fighting state capture and corruption. ________________________________________________________ The evidence and opinions presented here are the authors’ responsibility and do not necessarily reflect those of their respective institutions or their Executive Directors. The authors are responsible for errors and omissions. This paper is an output of the joint research project on governance, corruption and influence in transition conducted by The EBRD and The World Bank, and also serves as a contribution to the ‘Anticorruption in Transition’ Report (coordinated by the World Bank’s Europe and Central Asia Region) released at the September 2000 World Bank Annual Meeting in Prague. Details on the survey and data we utilize in this paper are contained in: ‘Measuring Governance, Corruption and State Capture -How Firms and Bureaucrats Shape the Business Environment in Transition’, World Bank Policy Research Working Paper #2312 (April 2000). All the outputs of this research project are available at http://www.worldbank.org/wbi/governance. The authors can be contacted at: [email protected]; [email protected]; [email protected]