A Model of Corruption and Foreign Direct Investment a la John Dunning

We model the relationship between foreign direct investment (FDI) and the level of corruption in multinational firms' (MCNs') home and host countries. There are two effects of corruption. The first is that host-country corruption reduces FDI by increasing foreign firms' costs. The second effect, based on John Dunning's theory that an MNC's skills reflect its home-country environment, leads MNCs to invest more in countries with corruption levels similar to those of their home country. MNCs develop skills for dealing with home-country corruption, and these skills become a competitive advantage in host countries with similar corruption levels. We test the model using bilateral FDI flows and find that both effects are economically significant