Foreign Direct Investment in Countries with Weak Institutions

The FDI behavior of a MNE facing a weak institutional environment in the host country is analyzed. Red tape can be strategically reduced by corruption centralization through informal self enforcing implicit contracts that cannot be enforced legally. The MNE trades the improvement of the institutional environment for a reduction in competition by the government. Rent shifting is possible through an incentive compatible FDI scheme which is robust to repeated interactions in a dynamic relationship when the corruption is stable. Improvement in bureaucratic behavior can benefit the country through an increase of the consumer surplus due to a fall of the marginal cost of the MNE. Centralization of corruption appears thus as a first step in the route of economic growth of countries with weak institutions.