Regulatory Capture by Foreign Corporations: Theory and Evidence from Sub-Saharan Africa

Abstract

Even in today’s “epoch of globalization,” there remain economic disparities between the world’s richest and poorest countries. In 2017, foreign direct investment (FDI) inflows totaled over US$1.52 trillion globally. The same year, FDI into sub-Saharan Africa totaled just US$28.5 billion, a little over 2% of global flows. To explain these disproportionate capital flows, scholars propose a range of theories involving poor governance, weak institutions, and lack of infrastructure. Historical political economic theories posit that higher levels of corruption, in particular, directly reduce levels of FDI. However, a puzzle exists in which levels of FDI inflows are rising across sub-Saharan Africa in spite of consistently high levels of corruption. Foreign capital is not responding to corruption pressures as theory predicts. Although, compared to the developed world, absolute levels of transacted capital are lower across the continent, they are nevertheless increasing in concert with corruption. I model interactions between a regulator and a multinational firm in a developing country as a principal-agent model with asymmetric information. The formal model shows that a state plagued by a corrupt bureaucracy can experience non-decreasing FDI inflows. More specifically, under the assumption that foreign firms cannot be expropriated from host countries, FDI levels can increase as firms compete for monopolistic power. Although corruption pressures vis-à-vis regulatory capture have the paradoxical effect of crowding in foreign capital, this comes at the expense of consumer welfare. Using an ordinary least squares regression and a hierarchical linear model, the empirical analysis supports these findings for forty-four sub-Saharan African countries from 2006 through 2019.