How Does Corruption Boost Financial Integration of the Developing Countries?

• In Event: Rule of Law and International Finance

Abstract

International political economy scholars have recently established that financial globalization can exacerbate domestic corruption in developing countries through neoliberal reforms that disadvantage specific businesses and public officials (Reinsberg, Kentikelenis & Stubbs 2019) and membership in international organizations (Hafner-Burton & Schneider 2019; Ferry, Hafner-Burton & Schneider 2020). However, the impact of political corruption on financial integration is understudied, despite theoretical links. First, high levels of corruption can be an incentive for foreign firms to invest if the countries also have restricted sectors. The entrance to these restricted sectors, which are unexploited due to lack of adequate capital, technology, production mechanisms, can promise rents exceeding the costs of bribery and potential punishments by home countries (Malesky et. al., 2015; Zhu, 2017). Second, the corrupt political elite also has incentives to hide their illicit gains in shell companies registered abroad as it is an easy way to launder the corrupt money into legal personal accounts. Also, the capital gains earned abroad are difficult for the tax institutions to observe, making foreign investments attractive. Although in corrupt countries policy level capital controls are circumvented, making de jure measures unreliable to display the effect of corruption, the data on actual capital flows and de facto measures of financial globalization make this hypothesis testable. Through an analysis of 121 developing countries for the years 1970-2015, this paper shows the positive effect of corruption on the financial globalization of developing countries.

Author

• Busra Soylemez, University of Delaware