The unexpected outcomes: how does climate finance affect corruption in developing countries?

Climate finance has become an essential tool for meeting the twin challenges of environmental sustainability and human development. However, in countries with weak governance structures, a large influx of external funds can distort incentives, encourage rent-seeking behaviour, and divert resources from planned projects. The purpose of this paper is therefore to conduct a preliminary analysis of the effect of climate finance on corruption in a panel of 130 developing countries over the period 2000 to 2021. The empirical evidence is based on the instrumental variable two-stage least squares (IV-2SLS) to account for endogeneity. Findings provide evidence that climate finance increases corruption in developing countries. This result is robust to additional controls, to the use of alternative corruption measures, and to alternative identification strategies. The heterogeneity analysis reveals that the effect of climate finance on corruption is not uniform across contexts. First, using a quantile regression approach, we find that climate finance has a less significant effect in countries with already high levels of corruption. In economic terms, the evidence suggests that the marginal impact of additional climate funds diminishes as corruption approaches a saturation point. Second, a regional disaggregation highlights substantial geographic variation: the effect of climate finance on corruption is strongest and statistically significant in Latin America and the Caribbean, moderate in Africa, and insignificant in Asia. Policy recommendations are formulated.