2.3. Corruption and the political risk framework
“Political risk is any political event, action, process or characteristic of a country that have the potential to, directly or indirectly, significantly and negatively affect the goal of a foreign direct investor” (Jakobsen 2012, 39). Whenever a MNC considers making a foreign direct investment based on any of the motivations outlined in the OLI-paradigm, all the possible costs to the profitability of the investment must be considered in a cost-benefit analysis. These costs, be they economic or political in nature, will affect the attractiveness and the degree of motivation the MNC will have for investing in a given country.
There are essentially four sources of political risk; the obsolescing bargain mechanism, political institutions, socio-political grievances and attitudes and preferences. In this literature, corruption is seen to work primarily through political institutions, but can also work through the obsolescing bargain mechanism. I argue that corruption is a phenomena in its own right, not just a characteristic of flawed institutions.16 These sources of risk act through mainly five different types of actors; Government, rebel/terrorists, non-governmental activists, other companies and foreign state or multilateral organizations. For the purpose of this thesis, in terms of potential costs, the government and state apparatus is the focus. There are primarily three different effects, government intervention (creeping or outright expropriation and renegotiation), war and unrest, and interventions by other non-state actors (Jakobsen 2012, 41).
As such, the political risk theory or framework posits that political factors and phenomena can be understood as factors that enter the cost-benefit analysis of multinational corporations when they decide if and where to invest. All political factors, decisions and events are seen as creating some degree of risk, a probability that it will negatively affect the economic profit of an investment.
Drawing partly on the political risk framework and the theories on corruption and its effects on investment I argue that corruption can have mainly three effects on multinational corporations, which will increase either the cost factor or the benefit factor in the corporations cost-benefit analysis when deciding to perform a foreign direct investment.17 The first is the potential
16 Investments in natural resources are particularly prone to this type of political risk. To the degree that corruption indicates or works as a proxy for political leaders with short time horizons and self-interested profit maximization, corruption will increase the likelihood that the deals and contracts negotiated beforehand between the MNC and the state could be renegotiated in lieu of the MNC’s decreasing power of negotiation as the capital and physical equipment is sunk into the investment in the host nation.
17 The political risk framework does not entirely suit my proposed framework for how corruption can affect FDI inflow. I therefore only borrow its mechanisms and proposed causality for how political factors can affect
24 benefits corruption can provide. By drawing on parts of the corruption literature, we can observe there have been several who state that corruption can provide opportunities that can decrease costs, increase profit margins of investments, give certain competitive advantages and provide access to otherwise unavailable sectors (Egger and Winner 2005; Huntington 1968; Leff 1964).
All else held constant, these benefits will increase the benefit factor in a cost-benefit analysis, and thus corruption can increase FDI inflow.
The second is that corruption can increase the risk of a foreign direct investment. When you bribe someone for a service, or collude with someone for a better deal or access to something, there is for example usually a monetary cost. However, corruption is by nature unenforceable.
You cannot know with absolute certainty that what you paid for is what you get, if you get something at all. The degree of risk corruption can create for an investment is dependent on many sub-factors, such as the size of the monetary cost, the familiarity and degree of systematism in the country regarding corruption, how likely it is to get caught, and then, how likely it is to get prosecuted and how likely it is that the media will run with a scandal and expose you to reputational costs (Busse and Hefeker 2007; Shapiro and Globerman 2002; Wei 2000).18 Disregarding all these factors, the key aspect that defines the risk effect is that it is indeed a risk. Relying on the seminal work of Knight, risk is something in which you can quantify to some degree the likelihood of success or failure (Knight 1921).
The third effect is that corruption can create outright uncertainty. To the degree to which you know nothing, or extremely little about how corruption will affect the security and profit margin of your investment, corruption is not creating a risk effect, but uncertainty. Uncertainty is separated from risk because you cannot quantify to any substantive degree the likelihood of corruption affecting your investment in a negative or a positive way (Knight 1921). For example, if you know country A is corrupt, and you know the political elite is corrupt, you might have to collude with a powerful individual or elite group. If you do not know at all whether they will keep their end of the deal you cannot calculate any probabilities, and you cannot work it into the budgeting of the investment. They are then just as likely to expropriate or renegotiate the investment once it is done, as they are to honoring their side of the deal.
Now, I would argue that these three factors are by no means separated from each other.
Corruption does not create either a degree of risk, uncertainty or some potential benefits. These
multinational corporations through their cost – benefit analysis. Political risk is far broader, and it is inherently negative for FDI, whereas I argue that corruption can also be positive.
18 This list is by no means exhaustive, but merely illustrating.
25 effects work together in relative size to each other. So, depending on internal (types of corruption) and external (contextual setting) factors, I expect that the degree of risk, uncertainty and potential benefits will change, relative to each other. If the potential benefits increase because corruption gives you access to and monopoly on an oil field, the effect of corruption will be quite different than if corruption gives you a small competitive advantage in a relatively small procurement process. The reason for this is that the potential benefits change relative to the risk and uncertainty effect corruption can produce. Referring back to section 2.2.2 and 2.3., I argue that political corruption will create more uncertainty because of its nature, bureaucratic corruption will primarily produce a degree of risk due to its nature, whereas the contextual factors will affect the relative size of both the degree of risk, uncertainty and potential benefits.
Thus, my proposed causal figure is the following: 19 Figure 3: Corruptions effect on FDI inflow:
19 Note that I in no way claim to prove causality in this thesis. Statistical techniques allow us to see correlations, and we can then apply theory to try to interpret causality. This is what this model is for, and it builds my expectations in regards to the effects of corruption on FDI and makes this clear to the reader.
Corruption
Political corruption Bureaucratic corruption
FDI inflow
Risk
Uncertainty
Other contextual factors (Political institutions, the courts,
natural resources, regime type, reputational costs, etc)
Benefits
Positive / negative
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