Effects of foreign direct investment on trade-based money laundering: The case of Vietnam

Abstract

This paper investigates the effect of foreign direct investment (FDI) flows on trade-based money laundering (TBML). Trade misinvoicing, including export under-invoicing and import over-invoicing, is a proxy of TBML. Using an extended gravity model in trade with data from Vietnam from 2000 to 2019, our empirical results show that FDI flows are positively associated with TBML, which supports the FDI-fueled capital flight hypothesis. Departing from the current literature, we show that this effect becomes pronounced for export under-invoicing when Vietnam trades with low-income and lower-middle-income countries. Moreover, this effect is negatively moderated by government effectiveness and economic freedom. Our findings are appealing because Vietnam is an export-oriented, FDI-dependent economy; however, trade misinvoicing may offset the contribution of FDI to Vietnam’s economic development. Hence, our findings suggest a number of policy implications for policymakers in attracting FDI.