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Less well documented is the fact that a similar pattern exists when the lack of competition is a consequence of artificial state controls over certain economic activities, which raise costs to entry Djankov et al. Click here to sign up. These differences can be observed graphically in Figure 4. Wiley Series in Survey Methodology. First, data is likely to be noisier at early years of registration, which tends to reduce significance of results.
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If we do say so ourselves. But we did. And we still love what we do every single day. We're so glad you're here. Trending Right Now. Our sponsors are cool. Support them. Work with us! Skip to main content. Log In Sign Up. Shang Khong. Edmund Malesky. Nathan Jensen. Dimitar Gueorguiev. Monopoly Money: Louis emalesky ucsd. Prevailing work argues that foreign investment reduces corruption, either by competing down monopoly rents or diffusing best practices of corporate governance.
We argue that this theory is too broad-brush and that the empirical work testing it is too heavily drawn from aggregations of total foreign investment entering an economy.
Alternatively, we suggest that openness to foreign investment has differential effects on corruption even within the same country and under the same domestic institutions over time.
Thus, we expect variation in bribe propensity across sectors according to expected profitability.
We test this effect using a list experiment embedded in three waves of a nationally representative survey of 27, foreign and domestic businesses in Vietnam, finding that the effect of economic openness on the probability to engage in bribes is conditional on polices that restrict investment. Word Count: Follow-up investigations demonstrated that Mexico was not an isolated incident, similar transgressions were found in Brazil, India, and China Clifford and Barstow The behavior of these iconic corporations in developing countries raises troubling questions for the International Political Economy IPE literature, where the dominant perspective is that opening a country to Foreign Direct Investment FDI should reduce corruption by either driving down monopoly rents or by diffusing best practices of corporate governance to domestic firms.
Our theoretical logic is straightforward — money talks. Sectors where foreign investment is restricted by licensing or regulatory barriers afford artificial monopoly rents to any firm that is able to enter.
Although each successive bribe within an individual sector provides diminishing returns for all entrants, the opportunity cost of not bribing early can be substantial, particularly in emerging markets.
Electronic copy available at: It is not FDI, in itself, that leads to reductions in corruption; rather, it is the erosion of monopoly rents, primarily through the removal of FDI restrictions which lowers the value for bribing by allowing more foreign firms to enter. Viewing the relationship in this way, suggests a clear-cut observable implication — in markets not fully open to foreign investment, reductions in corruption should be concentrated within those sectors that are exposed to foreign competition, not throughout the country generally.
Our paper makes two further contributions. While our empirical analysis cannot differentiate who initiates the bribe, our theory predicts that foreign firms are more likely to pay bribes in protected sectors.
Second, we test our theory through original, firm-level survey experiments conducted in three waves of an annual survey in Vietnam, where our dependent variable is designed to measure, as accurately as possible, the level of corruption experienced by an individual firm when registering its business.
As we highlight in Section 2, Vietnam offers a useful test for a link between openness and bribery due to a relatively high rate of corruption and because of a series of liberalizing reforms, namely the signing of several bilateral trade agreements, including one with the United States USBTA in , and World Trade Organization WTO accession in Critical for our test, these reforms were not implemented uniformly across all sectors.
Investment in certain sectors Group A sectors required special government approval for many years after the signing of trade agreements, and in some cases still does. We find that Group A projects were far more lucrative than projects in nonrestricted industries. After addressing endogeneity bias, in a given year, restricted sectors average 2. Further, we find that While foreign firms are no more likely than domestic firms to bribe overall, MNCs attempting to enter restricted sectors have a Others argue that the adoption of Western business practices and international preferences for transparency has an equally positive effect on how governments do business Sandholtz and Koetzle ; Gerring and Thacker Kwok and Tadesse articulate three pathways for diffusion: Some scholars have disputed the notion that openness reduces corruption, arguing that FIEs can actually exacerbate corruption in some environments Manzetti and Blake Others go further, arguing that FIEs face higher incentives to bribe for two reasons.
First, they need to overcome the liability of foreignness in competing against domestic firms with deeper market knowledge and better local connections. Second, relatively small transactions from the perspective of MNCs have a sizable impact on the living standards of local officials, and therefore can be more persuasive Tanzi and Davoodi The economic and business literature has highlighted how excessively high profit margins have been thought to indicate insufficient competition, which can incentivize corruption by investors.
It is the attractiveness of high profit margins associated with such monopolies that provide venal bureaucrats and officials with authority over the respective economic activity with the opportunities to demand bribes and kickbacks Ades and Di Tella ; Svensson ; Clarke and Xu Less well documented is the fact that a similar pattern exists when the lack of competition is a consequence of artificial state controls over certain economic activities, which raise costs to entry Djankov et al.
Heterogeneity across regulatory barriers allows for wide variation in the level of economic rents available across sectors. As a result of these regulatory protections, service sectors such as insurance provision, healthcare, and banking can sustain artificial monopolies and therefore provide the same types of opportunities for corruption as natural monopoly sectors, such as resource extraction and utilities Weeke et al.
In markets restricted by statute, ensuring economic rents by obtaining first-mover advantages, or queue jumping, can be a very tempting strategy for incoming investors Lui However, as Frye points out, the relationship is still in the hands of bureaucrats or politicians who can renege or renegotiate the contract, in our case - by removing barriers to entry.
However, to maintain rent streams, gatekeepers must continue to limit entry Shleifer and Vishny , Rajan and Zingales ; Benmelech and Moskowitz Thus, there is a tension between accepting bribes to allow firms to gain entry to protected markets and allowing too much entry, such that it increases competition and dissipates rents.
Testable Hypothesis The above discussion reveals a clear conditional empirical prediction that we analyze below. Foreign firms faced with the prospect of paying a bribe in low-margin sector, such as garment manufacturing, will simply decide to produce in another country if the bribe price equals or exceeds the expected marginal profit. Similarly, bureaucrats serving as gatekeepers are savvy enough not to demand bribes in these sectors, for fear that they will end up being responsible for losing valuable FDI projects.
All this changes, however, in sectors where entry is restricted by licensing requirements or business permits. Foreign firms have a significant incentive to offer bribes to enter these sectors, because of the high rents available post-entry. Similarly, local gatekeepers can demand greater compensation for allowing entry. In either scenario the propensity that a bribe will be expected and provided is parameterized by the rents available in a particular sector.
Thus, we hypothesize that: The propensity of foreign firms to bribe at entry is higher in restricted sectors Firms are willing to pay bribes for entry into these sectors, but only as long as politicians continue to limit entry and preserve the economic rents.
The removal of restrictions leads to a dissipation of these rents, limiting the ability of politicians to charge for entry into lucrative sectors. As countries sign investment arrangements as part of economic integration, restrictions to entry, and consequently the expected benefits of corruption, fall. We expect bribery propensity to decrease as well.
We remain agnostic on the relationship between investment restrictions and domestic firms, which offers countervailing hypotheses. While restrictions on domestic entry should have the same effect for domestic firms as specified in H1, the impact of restrictions on foreign entry into strategic sectors is predominantly based on the existing economic competition in that sector.
In most emerging markets, very few firms have the size and scale necessary to provide telecommunications, banking, or insurance services. As a result, logic suggests that the government does not need to limit domestic entry into these arenas. In these cases, foreign investment restrictions serve to protect these favored, domestic producers, and are likely unrelated to the decisions of domestic firms to bribe.
FDI in Vietnam Analysts of the Vietnamese economy often highlight the important contributions FDI has made to economic growth, trade, employment growth, and poverty alleviation throughout the country Tran Indeed, over the past two decades, Vietnam has benefited tremendously from FDI inflows.
A few sectors, however, were only partially liberalized according to the law. The stark difference between Group A and other projects became clearer after Vietnam decentralized FDI registration to the provincial level in the late s. While provinces could now register any FDI investment up to a specified amount locally, Group A projects still required central approval and a Prime Ministerial signature Malesky Leading up to the USBTA in , over thirty different economic sectors were protected by restrictive conditions on foreign investment.
In addition to the restrictions typical of any non-democratic economy, such as those of the press and national defense, Vietnamese restrictions also extended to finance sectors, retail distribution, and even some cash crops like sugar and tobacco. Table 1: Our data shows foreign entry into almost all restricted sectors over the period of observation. Nevertheless, the additional restrictions served to dampen competition and generate high rents for those lucky enough to enter them.
To assess sector-level variation in rents, we utilize two common measures of rents from the economics literature; a Herfindahl-Hirschman Index HHI 3 of market share Rosenbluth, ; and profit margins Boone Figure 1 studies the average HHI and natural log of profit margin experienced in Vietnam in a given year in both restricted and unrestricted four-digit ISIC sectors.
Clearly, Group A sectors have become significantly more concentrated than nonrestricted sectors overtime. For the entire time period under observation, restricted sectors averaged well above the 0. Beginning in about , however, restricted sectors became increasingly more concentrated, crossing 0. By contrast, nonrestricted sectors started off similarly concentrated, but have steadily inched downwards to below a 0.
The pattern is even starker when it comes to profit margins. Non-restricted sectors have seen their margins decrease steadily over time with increased competition; while restricted sectors have seen their margins explode, particularly after WTO entry in , which opened up lucrative opportunities for export, while creating temporary entry barriers at home through the phase-in of domestic treatment requirements.
Figure 1: Although the correlations between restrictions and potential economic rents appears strong, there is reason to be suspicious that the apparent relationship could be spurious, caused by omitted firm-level features driving both variables. These results are presented in Table 2, where the unit of analysis is the sector-year, between and for all sectors operating in Vietnam during that time. Models 3 and 8 add year dummies to make sure that our results are not simply capturing over-time trending in both the dependent and independent variable.
With year-fixed effects, this model essentially provides the HHI observed by survey respondents in the year they chose to invest in a given sector in Vietnam. Table 2: Labor Size s 0. Authors' estimates compiled using data from Vietnamese General Statistical Office Enterprise Census to available at www. The final models for each dependent variable Models 4, 5, 9, and 10 address the possible threat that endogenous regulation poses to our analysis. There is a first-mover benefit to early investors, who may lobby for regulations to protect their market share Rajan and Zingales ; Benmelech and Moskowitz ; Weymouth According to this theory, MNCs may be complicit in establishing the regulatory framework, using corruption to influence host-country officials.
If this is the case, the causal relationship could be reversed, meaning corruption might pre-date investment restrictions and available rents Bandyopadhyay and Roy Thankfully, the registry of Group A restrictions has only moved in one direction over time; restrictions have been removed and never added, limiting the threat that new restrictions emerged to protect early investors. Nevertheless, there remains a legitimate concern that the removal of restrictions and the length that they are in place, especially those that result from international agreements, may have been negotiated with an eye to entry by particular MNCs.
To account for these concerns, we employ a two-stage instrumental variables model, where we instrument for restrictions by the share of State-Owned Enterprises SOEs in the particular four-digit sector. This variable is lagged one year to account for the SOE share at the time policymakers were negotiating restrictions. We present our results of the first stage without year fixed effects Model 11 and with year fixed effects Model As Vietnam is still transitioning from a centrally planned system and has not undergone full-scale privatization, large, state-owned conglomerates are still active in many sectors.
There is strong reason to suspect that Group A restrictions were aimed predominantly at protecting their market share See Stigler ; Grossman and Helpman The IV strategy confirms this. Moreover, the size of the coefficients on restrictions and the R2 in both the HHI and profit models fall dramatically, indicating that our approach has removed a portion of the endogeneity bias. One fear is that lagged SOE share may violate the exclusion restriction by being correlated with HHI through channels other than investment restrictions, but this does not appear to be the case.
After ensuring exogenous regulation, accounting for market structure in Models 4 and 8, we find that restricted sectors lead to 2. Models 5 and 10, with year fixed effects, find 1.
A foreign enterprise lucky enough to enter a restricted sector can be assured of extraordinary market power and economic rents. Given our theory, we expect that foreign firms attempting to start Group A projects are far more likely to pay more for this privilege. In all three years, the sample frame for selection was the list of registered domestic firms and FIEs in the General Tax Authority database of registered operations. As a result, it is reasonable to ask whether nonresponse creates selection bias that might affect our conclusions Jensen et al.
Authority Databases, showing that PCI data reflects observable characteristics of the national population and therefore offers a highly accurate depiction of foreign and domestic investors in Vietnam.
There are currently 10, active FIEs in Vietnam, which includes 8, entirely foreign owned operations and 1, joint ventures JVs. Together, Taiwan Nevertheless, respectable numbers exist for Western investors as well.
Addressing Measurement Error with a List Experiment Contributors to the FDI-corruption literature come to the debate with strong theory and very poor data, which contributes to a confusing array of empirical support for all arguments, whether pro, con, or conditional.
The current approaches to studying openness and corruption are prone to five types of well-known biases: To put a finer point on this critique: Indeed, Treisman finds that perceived corruption is thought to be lower in countries with democratic institutions, media freedom, and high economic development, while it is perceived to be worse in poor countries, with more intrusive regulations, and less democratic protection.
Nevertheless, actual corruption, measured by the proportion of respondents self- reporting bribe payments is not associated with any of these political and economic factors Treisman Unfortunately, the factors that drive the measurement error in international indices of corruption will also be associated with the level of investment into and trade with a particular locality.
Consequently, we can never be sure of the true implications of greater openness. We attempt to correct for measurement error in perceptions of corruption by measuring corruption experience directly with respect to both foreign and domestic firms in one sociocultural setting but across different entry environments.
List questions are extremely easy to administer, as the respondent is not obligated to admit to engaging in a sensitive activity in any way. As a result, the respondent can reveal critical information without fear. The trick to the UCT approach is that the sample of respondents is randomly divided into two groups that are equal on all observable characteristics. One group of respondents is provided with a list of relatively infrequent, but not impossible, non-sensitive activities.
The second group, however, receives an additional sensitive item in the list. Respondents are only asked to tell the interviewer how many of the listed items they have either engaged in, and are specifically instructed NOT to identify which items they specifically engaged in.
Below is the UCT question included in the PCI surveys regarding bribery during business registration and licensing. An important feature of the question is that it is highly targeted and context specific. All of the activities listed are well known to businesses operating in Vietnam and would not be perceived as impossible or artificial, which might damage their confidence in the question. The survey question was administered in both Vietnamese and English. UCT Question 1: How many of the activities did you engage in when fulfilling any of the business registration activities listed previously?
Followed procedures for business license on website. By including this as nonsensitive item, we seek to only capture direct experience and conservatively estimate a lower bound on bribe frequency.
Because FIEs are more likely to hire facilitators, they have a slightly higher share of total activities in both control and treatment averages, but there is no bias in bribery estimates, which are the differences in means between control and treatment within a group. Whether a firm received A or B was determined by random sampling, so the two groups of respondents are balanced on all important observable characteristics.
If the activities are too frequent, a respondent in treatment may feel forced to answer the maximum number of activities including the sensitive item , thereby revealing their complicity directly. Alternatively, nonsensitive items that are too rare would have the opposite effect, allowing the respondent to believe that the sensitive item was the only reasonable option. In either case, the UCT would have failed and respondents would still be obligated to conceal their behavior. Our data did not appear to demonstrate such a tendency, as very few respondents in the control group answered the maximum number or zero nonsensitive questions.
It is important to keep in mind that our survey question relies on the ability of the respondent to recall the activities they engaged in during the last time they completed registration procedures.
Nevertheless, a small subset of operations completed registration procedures as long as 15 years before the survey. Although we could have chosen more proximate events for our survey experiment, the year a firm entered is critically important for our results, as we aim to take advantage of the changes in investment restrictions over time, paying special attention to the restrictions that were in place at the time a firm chose to enter the Vietnamese market.
To mitigate, we chose our activity items carefully, so that each represented an obvious action and was easy to remember. Nevertheless, such questions in firm-level surveys pose two dangers. First, data is likely to be noisier at early years of registration, which tends to reduce significance of results. Once again, this problem most likely will lead to noise and insignificant findings rather than biased coefficients.
In fact, our substantive conclusions remain and actually strengthen when we restrict the analysis to firms registered within five years and even two years of the survey. Once a survey is completed, a simple difference-in-means test between the treatment and control groups can reveal a population proportion equal to the prevalence of the sensitive behavior or belief.
These results are shown in Figure 2. Diamonds and squares identify the average number of activities for treatment and control groups respectively. The range bars around the mean scores are 95 percent confidence intervals.
The first thing to notice is that the range bars do not overlap in any of the survey years, indicating the differences in means are statistically significant and therefore that the treatment was effective.
To calculate the percentage, we must now only subtract the treatment average from the control average 1. The difference between these means is 0. The name and position of the respondent are maintained in the dataset, giving us confidence that delegation is not a major threat to our analysis. In , a blank space was provided for respondents to record the number of activities in which they engaged. Very few respondents 0. In , however, all values between zero and three or four for the treatment group were provided, and respondents could check the appropriate value.
Although, this change should not affect calculation of bribes, calculated as the difference between treatment and control within a given year, it does influence the total number of activities. To make sure our results are not an artifact of this innocuous change in survey design, we run our analysis with survey year fixed effects. Figure 2: As we argue, it is not a coincidence that bribery upon registration increases for foreign firms after , about the same time that HHI and profit margins diverged between restricted and unrestricted sectors.
Figure 3: Here, we provide difference-in- means tests of number of activities engaged in during registration for domestic and foreign firms in restricted and unrestricted sectors. Once again, calculating the difference between treatment and control groups provides the share of firms engaging in bribery during entry procedures. Table 3: Firm-Level Empirical Analysis In this section, we adapt a two-stage non-linear least squares NLS estimation model developed by Imai which extends the difference-in-means approach used above to multivariate estimation.
The Imai process involves fitting a model to describe the control group, then using the estimated coefficients to predict new values for the treated group, and finally fitting the imputed values over the observed in the treated group through an expectation algorithm to produce estimators for each variable included in the following model: Because the dependent variable in the second stage is an estimate, standard errors are calculated using bootstrapping with 1, replications.
When there are no covariates independent variables introduced in the model, the estimator reduces to the difference-in-means estimator. This can be seen in Model 1 of Table 4, which replicates the difference-in-means estimator from above. Note that the constant is. Also note that the number of observations 10, is about half of the true sample of firms, as the second stage is only performed on the treatment group.
In the first stage, the number of nonsensitive activities is regressed on the covariates for the control group using a negative binomial specification.
The predicted number of nonsensitive activities is then subtracted from the total number of registration activities for the treatment group.
Note that the number of observations N is the number of respondents in the treatment group.
Errors are clustered at the province level, which is the main interface for business registration. Model Specification Our first theoretical expectation is that prevalence of registration bribery is likely to be higher when foreign firms seek to enter sectors that are designated as Group A projects. Thus, we expect that g, the predicted proportion of firms paying bribes is determined by the following equation, where i is an index of firms and t indexes the year they completed registration activities.
We control for Capital Size, as Harstad and Svensson argue that large and important firms are less likely to bribe, because they can rely on lobbying to circumvent difficult regulations. Since FIEs are generally bigger than their domestic counterparts in the same sector, it is critical control for initial size to avoid omitted variable bias.
To do this, we use an eight-point categorical variable representing the amount of registered capital for domestic firms or the operating license size for foreign firms at the time of entry 1: Model 4 then provides the interaction between FDI and restrictions that serves as the core test of our theory.
Model 5 adds a quadratic time trend, measuring years since registration, to ensure that the relationship is not a function of trending in both corruption and restrictions over time. To address further omitted variable bias, we add a series of control variables for firm and provincial level characteristics in Model 6.
In many cases, these formally state-owned firms have maintained the same directors and top managers and therefore have a far different relationship with bureaucrats, especially with local registration officers, than greenfield private investment.
We might expect that these firms are less likely to bribe, because they can rely on their close relationships with officials instead. A further test of political connections as a substitute for corruption is supplied by whether the current manager is a former government official, SOE manager, or army officer. Finally, bribery may be a function of general optimism on the part of an entrepreneur, rather than the rents associated with a particular sector.
Because we want to isolate the generalizable aspects of corruption, we control for firm-level optimism in Model 7, by including a variable called Expand, which measures whether the business has plans to expand its production, investment, labor force, or add to its product lines over the next two years.
To ensure that our results are not caused by recall bias resulting from firms that registered many years earlier or from a particular era of regulatory development, we restrict the sample to firms that registered after in Model 8. This has two additional benefits. First, it addresses the fact that registration procedures changed dramatically for private firms with the Enterprise Law, which reduced the number of licenses and put a cap on waiting periods to receive registration approval Perkins and Vu Results The results offer strong evidence for our hypothesis that FIEs are more likely to bribe in restricted sectors.
In the fully specified Model 7, when competing in nonrestricted sectors, FIEs are not significantly more likely than domestic firms to pay bribes during business entry. The coefficient on restricted is negative and also insignificant, indicating that domestic firms in restricted sectors are only marginally less likely to pay bribes than domestic firms in nonrestricted sectors. Finally, the coefficient on the interaction is substantively large and highly significant 0.
These differences can be observed graphically in Figure 4. After removing early registrations in Model 8, the confirmation for our theory is further strengthened as seen in Figure 4. In the first panel, we compare the difference in coefficients between FIEs in restricted and nonrestricted sectors for the full sample and post registrations.
In the second panel, we compare coefficients between foreign and domestic firms within the same Group A categories. In both cases, the differences are significantly above zero marked with a dashed lines , providing strong confirmation for our first hypothesis.