Effects of Corruption on Capitalism and Foreign Investment

Capitalism is defined as an economic system where the ownership of the capital goods is either in the form of private or corporate ownership. Additionally, the production, distribution and the determination of prices of goods is left to the determination of the free market. Under capitalism, the government exists only to protect the rights of the individuals through provision of a stable army that can protect the nation from getting an external attack. Additionally, the traders are protected by the police force that guards them from getting an internal attack from criminals. Finally the government provides for the existence of a court of law that is responsible for punishing the offenders in accordance to the provisions of the law.

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For most of the developing economies to grow and reach the level of the first world economies, then they need to have free markets that are free from corruption. However, most of the developing economies have gone through a lot of stumbling due to the massive corruption in their countries. By allowing corruption to creep in within the political arena, it gives room for the creation of instability within both the business and the financial environment. For instance those who get into political positions through corruption are most likely to allow for the issuance of work permit to foreign firms that do not even deserve to get them. Additionally, such leaders would in most cases try to use dubious means to distort the free movement of prices of commodities in the market. Corrupt leaders allow for the formation of cartel groups and monopoly groups that distort the prices of commodities within the markets (Deresky, 2011). A market that is characterized by such factors is normally avoided by the foreign investors since they fear losing out on their business ventures.

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Corruption does have a negative impact on the foreign investment because for one, corruption will lead to high transaction costs from the foreign investors. The high transaction costs arise as a result of the investors having to pay the extra coin in order for them to be allowed to progress with business transactions in that country. The extra amount that is imposed on the foreign investors is finally reflected on the pricing strategies of the investors. In order for them to compensate for the extra amount, the investors increase the prices of their commodities (Mauro, 1995). The extra coin that is reflected in the investors’ prices is most likely to affect the competitiveness of the investors pricing strategies. For instance if such an investor raises his commodity prices to a level that a little higher than market prices, then he will most likely lose out on the customers.

Apart from the pricing policies and profit making, a firm that is based on corruption practices might get damage on its reputation once it gets exposed on its corrupt scandals. The members of the public will automatically have a changed perception of such an organization if its dirty deals are exposed. The ripple effect is that the firm will most likely lose out on its competitive advantage in the market where it had initially dominated. If for instance, the firm is one that deals with fast moving products such as food items, the members of the public may shy away from purchasing their products. If that happens, then the goods will most likely expire before they are sold out due to the boycott from the customers.

Apart from that, corruption distorts prices of commodities in the markets where some firms are given a competitive advantage over their rivals in the same markets. In such cases, social unrest may eventually erupt causing a political instability in that country. A country that often undergoes social unrest normally scares away foreign direct investors (Heidenheimer, 1996). If the investors get scared away, the country loses out on taxes that it might have collected from such businesses. If the government fails to get the taxes from the business operations of the foreign firms, then business operations of the governments might be crippled. Every sector of governments depends on the collection of taxes for them to function effectively. Without such resources then almost every sector of the government may come to a standstill. If the various wings of the government get crippled then such a government can be said to be ineffective.

The multinational corporations in most cases shy away from doing business in countries where corruption is rampant. They will instead move away from such areas and instead invest more in countries where there are very low levels of corruption. The foreign investors would prefer doing business in countries where they can keep their operation costs as low as possible. Low operation costs will eventually result in high profit margins for their firms. The higher the profit margins of such firms, the more the competitive advantage such firms would have in the global arena.

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