Introduction
The role foreign direct investment (FDI) plays in ushering economic growth in developing countries cannot be accentuated as much as necessary. FDI is a well-known catalyst in boosting investment in the domestic market. Further, FDI helps in transferring of technology and scientific expertise in the developing countries, as well as in building capacity for production.
For many African countries that were in dire need for development, FDI inflow helped in development and bringing modernism, especially when many of these countries were recovering from long lasting stagnations. Many believe that the capacity of African nations to attract FDI is through the store of their natural resources and the size of the local market of the country. In recent past, Nigeria, Angola countries have been successful in attracting FDI due to their ample oil resource, regardless of their unsound political and economic environment.
Transnational companies have shown little interest in African countries in terms of investment reflects the need for policy reforms and change in business environment in African countries. It is often argued that over the past decade, African continent has been a less favored destination for foreign investment in comparison to Latin America and Asia. The argument against any implementation of FDI in African countries has been lack of reforms and foreign investors have shown reluctance to invest just based on availability of natural resources in the country. Therefore, the dearth of FDI implementation in African countries is the result of unstable economic condition with state intervention in business that makes investment non-conducive.
Since 1990s, many of the Sub-Saharan countries in Africa have demonstrated striking growth rates. It is during the period that many of these countries had successfully attained double-digit growth rates. In terms of FDI inflow in African countries, the inflow as a percentage of GDP increased by 0.73 percent in the 1990s, while it increased by 2.43 percent in the 2000s. Further, FDI inflow as a percentage of GDP in all African countries except South Africa on an average in the 2000s was 2.61 percent. Table 1 demonstrates the increase in FDI inflow in the African continent during the decade of 2000s. The maximum growth in FDI inflow has been observed in Sub-Saharan during the period that showed an average FDI flow as percentage of GDP to be 3.08 percent. However, the region that showed the maximum increase was Sub-Saharan Africa. This is demonstrative o f an increasing interest of foreign investors in investing in the African continent.
Table 1: Average FDI inflow as percentage of GDP
The above table demonstrates that some countries have been successful in increasing their FDI inflow while others have not been so successful. The continent did not benefit from the FDI boom that took place in the 1980s, due to weak economic and political performance in the continent. The reason for FDI holiday in African has been due to its instable political situation, wherein military conflicts were common and economic depression that made an investment a wrong proposition. Though there was a significant increase in the FDI inflow in Africa since the late 1990s, the inflow was observed only in a few countries like Angola, Nigeria, and South Africa and other smaller countries like Lesotho, Namibia, and Uganda. In these countries the share of FDI in GDP became significantly high.
Even though there has been a significant rise in the FDI in Africa during the period, the share of FDI inflow to that of FDI flow has declined. Africa’s share in the global inflow of FDI has been higher in Africa in 1980s, that declined in 1990s, though overall inflow of FDI increased in 1990s. However, share of Africa to world FDI inflow increased considerably in 2000-09 when it increased from 0.7 percent in 1990s to 1.2 percent in 2000-09. The reason was due to the recurrent political and economic problems in the continent that plagued the continent.
The conventional belief in the economics is that with the increase in the inflow of foreign investment there is expected to be an increase in growth and development in the region. Therefore, with the increased flow of FDI in Africa, there should have been, according to this argument, an increase in the growth and development in the economy.
However, with the recent financial crisis the flow of FDI worldwide has declined. As in case of Africa, the economy has been said to lose export of $578 billion that is equivalent to 18.4 percent of the GDP (Ali, 2009). According to reports, the FDI inflow as share of GDP has reduced considerably, from 3 percent in 2008 to 1.8 percent in 2009. This has led to hindrance to the economic growth of the continent. In this light of the global recession, the African continent is said to have suffered tremendously due to the reduced inflow of FDI. Therefore, a study of the effect of lowering of FDI flow into Africa due to the recession is necessary.
This paper will study the implementation of FDI in Africa, and the effect it has had on the economic growth of the continent. The paper will first see the effect of the impact of FDI on the economy from two angles – regional growth and growth pertaining to any particular sector. This would studies the variables that affect the flow of FDI in sub-Saharan Africa (SSA) from the period 1990-2009. This period is particularly important for the study as it concentrates on the recent recession and its effect on the SSA economy and its effect on the FDI.
Literature Review
FDI boomed in the world economy in the 1980s, when there has been an increase in the growth of foreign investment in the economy. This chapter will describe the historical background of FDI in the world economy, then its inflow into the African economy, and the effect on the economy due to the implementation of FDI in the African economy. This section will primarily describe the literature on FDI in general and then specifically in Africa. In course of the literature review, the chapter will also discuss the trend in investment and the effect on the African economy, and how the recent recession has affected the FDI inflow.
Historical background of FDI
Foreign direct investment or FDI essentially, to a layman, means to increase contribution of foreign investment to domestic markets. Literature provides various definitions for FDI. FDI may be defined as the long-term investment made in a foreign enterprise in order to obtain a higher stake in the management of the organization (Bjorvatn, 2000). In another definition of FDI, it is considered a process in which a home based organization acquires the ownership of a foreign-based organization by means of which they are able to control the production, distribution, and other related activities of the firm.
In another definition of FDI, it is assumed assets acquired anywhere outside one’s home country. These assets can be in form of bonds, bank deposits, real estate, or shares. When a firm invests directly in the production process of a firm it is considered foreign investment. This also involves acquiring ownership of plants or exchanging technological knowhow. FDI is also investments made in the constructional and production process of other countries as in case of companies based in countries abroad.
The theoretical literature of FDI conventionally paid attention to Greenfield investment. A form of FDI literature focuses on merger and acquisition (M&A) across borders. Navaretti & Venables (2004) has distinguished between M&A and Greenfield ventures by taking the assumption that a merged firm usually negates one of varieties and the fixed cost that is associated with joining the firm. This is common in case of Greenfield investment, wherein, the M&A across the border becomes more lucrative and profitable as the cost of trade increases over time. Another approach that has been observed is to concentrate on the structure of the market and its implications to M&A (Head & Ries, 2008).
However, this approach considers the possibilities of asymmetrical cost structure during the process of acquiring and that of the targeted firm. In this model of FDI, a low cost firm acquires, and eventually shuts down a high cost firm abroad. According to another theory, M&A allows firms to access a foreign firms’ non-mobile capacity (Head & Ries, 2008). There are different modes that are chosen by firms to enter into a foreign market. Nock and Yaple (2005) demonstrates that M&A in the international market occurs between diverse businesses and varieties. From the study of these papers one thing is imminent i.e. the existing friction in the cross border possession.
Some theories show that FDI brings forth market imperfections in form of monopolistic competition or oligopoly. In such cases the firms acquire form specific asset, and helps foreign companies to create barriers for new entrants in the market (Voutilainent, 2005). Therefore, according to this theory, companies that are monopolistic in nature undertake foreign investment.
Further, many companies develop sophisticated information that companies transfer to foreign markets in forms of FDI. This is said to be the internalization theory. This theory postulates that the there is a cost saving related to the transferring of information internally (Voutilainent, 2005). Therefore, through the internalization of information across international boundaries helps in creation of multinational corporations (MNCs) where knowledge and information happens to be the key factors helping in creation of market imperfection.
The main motives for entering a foreign market through FDI for companies are to gain resources and/or efficiency in the market. This helps in determining the determinants of FDI. This brings forth the belief that FDI inflow increases where there is abundance of natural resources. According to Loots (2000) the resources that drive the flow of FDI in an economy are the availability of cheap unskilled labor force, skilled labor, and the nature and worth of infrastructure. Therefore with the availability of abundant natural resources in Africa, a large amount of the FDI inflow should flow in the primary sector of the country. As in case of FDI inflow in less developed countries (LDCs) like Chad, Guinea, Angola, and Sudan that have abundant resources, is mostly in crude oil exploration projects (Moolman et al., 2006, p.5).
The main aim of FDIs is to gain market and serve the domestic market. This implies that the products that are manufactured in the host countries are sold in the local markets. Thus, this kind of FDI is flown in due to the degree of domestic demand characterized by a large market or high income of a large section of the population in the host country (Asiedu, 2002). Therefore a market seeking FDI will always look for a large buying market, or high income and income growth in the host country for investment. Such kind of FDI is also named as horizontal FDI as this process entails building of a firm in the foreign country for catering to the local market (Lim, 2001, p.11).
Some foreign investors indulge in investing in foreign countries in order to seek greater efficiency or reducing cost of production (Hawkins & Lockwood, 2001). These FDIs aim at minimizing cost of acquiring factors of production globally. The aim of the FDI is to attain efficient utilization of labor, cost of resources, and to participate in regional integration. These kinds of FDI are abundantly found in countries where there is abundance of labor force and technological expertise (Hawkins & Lockwood, 2001).
When both kind of FDIs i.e. the market seeking and the efficiency seeking investments cluster in certain locations they are said to be the agglomeration effect. This may result from existing linkages between projects that may help in having close locations. Alternatively, when firs are uncertain about success in a country, they may engage in “herding behavior” before they enter a new market (Lim, 2001, p.11). Therefore, one of the factors that may attract new FDI is through the success or failure of pre-existing foreign investment in the country.
Many believe that not all FDI is good for the host country. One such kind is resource-seeking FDI. This kind of FDI implies low value added to the projects and implies low capital expenditure done by the foreign company on the host country, thus, indicating lower return of benefits (Narula & Dunning, 2000, p.151). Further, a country’s present development stage would also indicate the kind of company it wants to attract in order to pave a path of development through foreign investment. Therefore, foreign companies should be concerned to invest in activities that entail in activities that add higher value that may concern either market seeking or asset exploitation of the host country (Narula & Dunning, 2000, p.160).
Therefore, the above factors listed in the above section indicate the factors that determine the causes for which foreign organizations invest in other countries. Inversely, these factors also imply how these factors become the factor for which a company is attracted to a foreign country.
Determinants of FDI
Many researchers have segregated the determinants of FDI inflow based on the motivation studies. According to Nunnekamp (2002) globalization has changed the nature of FDI has altered tremendously over the years. This has made him differentiate FDI determinants based on traditional and non-traditional categories. Others like Tsai (1991) whose study is based on production side have differentiated the FDI determinants as the supply and demand side categories. Push and pull effects have been considered as the determining factors of FDI in case of identifying the characteristics of countries (Ahmed et al., 2005).
While studying these determinants it is important to point out that these determinants may sometimes overlap. The identification of the determinants is important, as they would give the right direction for the policy makers. The main aim of this field of studies was to identify the factors or determinants that put substantial effect on FDI.
Tsai (1991) points out that the importance of differentiating between the supply and demand side determinants is that the demand side determinants are the variable that can be controlled by the country to some degree. The demand side variables are determined by aggregate variables like gross domestic product (GDP). On the other hand, supply-side demands are determined by microeconomic factors such as the firm and the market structure is determined through firm level data.
Resource seeking FDIs are considered traditional determinants, while efficiency seeking FDI are considered non-traditional form of FDI. The reason for classifying the determinants in this matter is to ascertain if the variables change over time especially in developing countries. Due to globalization, FDIs that were priory natural resource seeking is tending to become more efficiency seeking (Nunnenkamp, 2002).
Loots (2000) classify FDI determinants in three categories based on locations. These are based on security and political condition, macroeconomic condition of the country, and facilities provided to business. They are further classified into policy and non-policy related factors. This distinction is made based on the policies that are made by the authorities to influence the project.
According to the push and pull theory wherein push factors are related to external factors and the latter relates to domestic factors broad macroeconomic, policy, and institutional variables affect the flow of foreign investment in the host country (Ahmed et al., 2005). They also argue that the push factors are capable of explaining the distribution flow of the foreign capital in the country. Therefore, host countries may adopt these determinants in order to improve the flow of FDI in their country.
FDI is determined mainly according to the factors or variables identified in the FDI inflow literature. In this section, a few, and most well-known determinants of the FDI are studied. One of the most important determinants of FDI as identified by Loots (2001) and Asiedu (2006) is market size. They argue that the larger the size of the market, the lower is the fixed cost of production and greater is the economies of scale. A larger amount of FDI inflow will increase the amount of goods and services produced.
Foreign exchange rate and its stability affect FDI inflow. Foreign exchange may lower the cost of production of the foreign companies and therefore, increase the competitiveness of the good produced in the host country. However, there is no consensus among researchers on the relation between FDI and exchange rate. Lim (2001) believes that a high exchange rate would imply that the raw materials in the host countries become cheaper for foreign companies, and therefore, attract more FDI. However, with decline in exchange rate, actually means that foreign companies can earn more foreign currency and therefore increase FDI.
Higher inflation actually implies that the fundamentals of the country are weak, and therefore, would attract less FDI (Onyeiwu & Shrestha, 2004; Asiedu, 2006 ). In another way, higher inflation can increase the cost of capital and production in the host country, therefore, making it an unattractive destination for the foreign company.
A country’s openness to trade is also a determining factor of FDI inflow. Countries that have less restrictive policy regarding foreign trade and fewer controls over capital investment will attract great FDI (Onyeiwu & Shrestha, 2004). As in case of South Africa, the flow of FDI was very low during the time the country followed apartheid.
When the host country faces a high external debt, which is indicative of inapt economic policies that discourages foreign companies from investing in the country. Countries that have less debt burden are expected to have better basic infrastructure facilities and therefore would attract more FDI (Onyeiwu & Shrestha, 2004).
Taxes are an important factor that foreign investors consider before undertaking any foreign investment. Onyeiwu & Shrestha (2004) suggest that a high tax rate would deter foreign investors while lower tax rates would attract FDI. However, some believe that tax rate do not have a significant influence on determining the foreign investment (Narula & Dunning, 2000).
Higher labor cost indicates that cost of production for a foreign company would be higher. Therefore, when the host country ahs high labor cost, it will attract less FDI (Lim, 2001). The FDIs that seek efficiency through foreign investment would not be interested in investing, as it will reduce its cost efficiency.
According to Ahmed et al. (2005), a well-established financial market would attract short and long-term foreign investment more easily. These finances may be through the banking sector or through debt instruments.
The size of the government also affects FDI inflow. Some scholars believe that smaller governments (i.e. governments with less capacity to spend on development activities) attract more FDI.
Onyeiwu & Shrestha (2004) suggest that coutnries with better infrastructural facilites such as better roadways, uninterrupted water supply, and electricity would attract more FDI. Thus, a positive relation between FDI flow and infrastrucutre can be expected.
Availability of natural resources, as in case of Africa, is found by some scholars to have a positive effect on FDI inflow (Moolman et al., 2006; Asiedu, 2006 ). The reason for is that the foreign investment in these African countries are based on exploiting these natural resources. Therefore, greater is the availability of natural resources, FDI flow would tend to be higher.
The amount of FDI stock of the country is also a considering factor for determining the inflow of FDI. Therefore, greater the stock of FDI in a country, greater is the amount of FDI flowing into the country (Lim, 2001).
Fiscal incentives that are actually indicative of government policies and regulations are a deciding factor for FDI inflow. When the fiscal incentives are higher it increases the locational incentive of the host country (Lim, 2001; Asiedu, 2006 ).
The business environment of the country also affects the host country’s capability to attract FDI. This indicates a less regulations and lesser judicial hazards. To facilitate the business environment, local government may also include policies to attract FDI inflow.
Political instability is a big set down for FDI inflow (Onyeiwu & Shrestha, 2004; Asiedu, 2006 ). When there is no political stability, there remains no security of operations for the foreign companies, and thus, they prefer not to invest in politically unstable regions.
FDI in Africa
This section is dedicating to studying the previous researches that has been done on FDI inflow and implementation in developing countries, especially on African countries.
Ahmed et al. (2005) studied the determinants of FDI in 81 developing countries. He used least square method and general methods of moments for the calculation for data ranging from 1975 through 2002. According to their study, lagged dependent variable creates bias in least square estimates and therefore provides inconsistent results. The general method of moment provides unbiased results. They show that the external factors that are termed as push factors such as international rate of interest and the global business cycle are related to inflow of FDI. Ahmed et al. point out at broad categories such as performance, external factors, business environment for investment, natural resources, and infrastructure.
According to their study, agglomeration effect creates clustered FDI inflow in a region. Therefore, their study implies that past stock of FDI helps in attracting new FDI. Further, the study is also indicative that macroeconomic factors such as higher growth rate, open economy, and good infrastructure help in attracting FDI. The push factors that help in attracting FDI are higher opportunity cost of the host country, higher interest rate, etc. their study also shows that higher inflation and volatile exchange rate can deter the flow of FDI in the country (Ahmed et al., 2005).
Loots (2000) studied top ten developing countries in order to ascertain the factors that determined the variables that affect FDI inflow. He classified the factors based on business facilities, policies, and economic factors. According to his findings, policy is found to be a necessary but not sufficient condition for the determination of FDI inflow. Loots also demonstrate that fiscal policy, taxes, and political stability are not found to be important factors in determining FDI inflow in the top ten developing countries studied. However, the study indicated that domestic market is a strong factor to attract FDI (Loots, 2000).
Nunnenkamp (2002) studied the effects of globalization on determinants of FDI, using simple correlation of 28 developing countries. According to this study, the importance of market size in relation to the FDI inflow has declined during the era of globalization. Other determinants like locational advantage, cost of production, labor cost, infrastructure, etc. have gained significance in determining FDI inflow.
According to Tsai (1991), a study of Taiwan showed that demand side determinants determined FDI using time series data. Using ordinary least squares method, the study segregated between demand side determinants and then a ration of GDP was used in order to negate any supply side influence on the equation. According to Tsai’s findings, cost of labor, government policy in terms of incentive, and market size are the important factors that had influenced the flow of FDI in the country.
A cross-country study conducted by Asiedu (2002) studied the factors determining FDI in Sub-Saharan Africa (SSA). She studied if the factors that determine FDI in developing countries have a different effect for African nations. This study was conducted on 71 developing countries of which 32 were SSA countries and rest was non-SSA. Using ordinary least square method, the data was analyzed, and the results demonstrated that good infrastructure and higher return on investment had a positive impact on FDI in non-SSA countries, whereas, in SSA countries did not play as an important factor. Another finding suggests that an open to trade economy helped in FDI inflow in both SSA and non-SSA countries and the geographical location was a disadvantage and impediment to the inflow of FDI in SSA.
In another study Asiedu (2006) on determinants of FDI in Africa showed that the analysis of the panel data of 22 African countries from 1984-2000 indicated the importance of market size and natural resources as the determining factors of FDI. Further, less inflation, corruption, and higher political stability is found have a positive effect on FDI flow. The result shows that countries with low level of natural resources can attract FDI by improving their policies and business environment.
Asiedu & Gyimah-Brempong (2008) studied the effect of globalization on the determinants of FDI in African countries. They studied data from 33 countries from 1984-2003 and used a dynamic panel estimator to conduct the analysis. According to the results of the study, liberalization of the countries has had an important effect on the FDI investment of a country.
Trend of FDI in Africa
Basu & Srinivasan (2002) point out that the stock of FDI in Africa increased considerably between 1984 through 2000. Nevertheless, the share of Africa in global FDI stock declined from 5.3 percent in 1980 to 2.3 percent in 2000. The inflow of FDI also remained low at 3 percent after 2000.
Asiedu (2008) mentions that the FDI inflow in Africa was mostly (around 65 percent) were absorbed by countries like Angola, Nigeria, and South Africa. It is argued that the countries in SSA are small – 23 countries out of 47 African countries have a GDP less than US$ 3 billion.
According to World Investment Report (WIR) of 2010 the recent recession globally that caused the global demands to decline considerably led to a decline in the FDI inflow in the African countries (World Investment Report , 2010). In 2009, the total inflow of FDI in Africa was US$59 billion that was a 19 percent decline from 2008. The WIR report showed that the difference in the inflow of FDI differed between regions. As in case of West Africa and East Africa that has received the maximum of commodity related investment underwent a decline in investment during the present recession.
North Africa also experienced a decline in FDI even though the FDI portfolio of the region showed immense diversity. Central Africa is the only region in the continent that showed an increase in FDI flow, largely due to investments in Equatorial Guinea. Even during the recession, South Arica received the maximum amount of FDI in the continent, even though the inflow of foreign investment declined during the recessionary period.
FDI in Africa is mostly dedicated to mining operations. However, according to WIR 2010, 41 percent of the Greenfield investments FDI in Africa are dedicated to manufacturing during 2003 and 2009. Of this, metal comprised of 9 percent.
A comparison of the FDI inflow to the total global stock shows that Africa has the lowest share to world total inflow of just 5.1 percent as compared to 5.5 percent of Latin America and 6.7 percent of Asia in 1995-1999. However, when considering the period from 2000-2008, the FDI inflow share of Africa declined to 4.9 percent as opposed to 0.7 percent in Latin America and 15.2 percent in Asia (World Investment Report , 2010).
A few African countries have introduced policy changes in order to attract FDI in their country. Gambia and Morocco induced a decline in corporate taxes in order to attract greater FDI inflow. Rwanda and Libyan Arab Jamahiriya introduced policies to improve the general investment environment of their countries. However, due to recession, a few of the African countries also tightened their regulatory framework. As in case of Nigeria, it introduced local content requirement for any foreign investment. Algeria introduced a policy that limited the scope of foreign ownership in certain sectors of the economy.
Figure 1 demonstrates that the share of FDI in the region has declined as compared to the 1980s standard. However, there have been fluctuations. As a percentage of total world FDI inflow the FDI in Africa showed a declining trend, however, as a percentage of GDP, the FDI in Africa definitely showed a rising trend, with minor fluctuations in 2005 and 2008, probably due to the global recession. This indicates that though the overall flow of FDI in the region has been increasing, the share of FDI of the region in the global inward stock has been declining, therefore indicating a declining preference of the region as a preferred region for investment.
The literature review therefore demonstrates the factors that previous literature has indicated as the determinant variables of the inflow of FDI in a country. The review however, does not indicate any study that has considered the change in FDI flow in Africa due to the recession. Therefore the aim of the paper is to ascertain the determinant factors of FDI inflow in pre and post recessionary period of 2007. The next section presents the methodology that has been adopted for analyzing the data.
Methodology
This section provides a detailed description of the model selection and the method of variable section and analysis. This in detail presents the methodology followed for data collection, interpretation, and analysis.
Data
The data collected for the present research consists of 22 SSA from the period 1990 to 2009. The dependent variable, as is observed from the previous literature on FDI, is net FDI flow as a percentage of GDP. All data that has been used for the research is collected from World Bank dataset (World Bank, 2011) and United National Conference on Trade and Development (UNCTAD) dataset (UNCTAD, 2011) unless specifically stated otherwise. The countries and the years included in the regression analysis depend on the availability of the data. The summary of the statistics used for the analysis is presented in table 1.
Description of the Variables
Policy related variables
These variables are the ones that are determined by the policies made and/or altered by the government. Therefore the policymakers have direct influence on these variables. The policy variables that have been included to decide on the macroeconomic stability, infrastructure, human capital and openness are follows – inflation as measured as GDP deflator (INFLATION), literacy as percentage of total literate population above the age of 15 years (LITERACY), internet users (INFRA).
The measure of openness as used mostly in the literature reviewed on FDI is percentage of trade in GDP (Asiedu, 2006 ). When this demonstrates a positive relation between FDI and net trade volumes this implies that the country intends to attract greater amount of FDI into the economy. According to Morisset (1999), “Most recent studies have also evidenced that the degree of openness, as measured by the trade share in GDP, should influence positively foreign investors through trade liberalization and higher competitiveness.” (11) However, some economists believe this kind of policy suggestion is not steady, as this is not directly controlled by the policymakers. In addition, following this argument, many researchers like Asiedu (2006) have adopted the International Country Risk Guide. This argument is not completely true as trade as a tool to demonstrate the openness of the economy has been employed by many countries and therefore is a possible and helpful tool to influence trade. However, for this research we use the conventional method usually employed in FDI literature i.e. trade as a percentage of GDP as the measure of openness (OPEN). Therefore the net trade balance as a percentage of GDP is taken as the measure of the variable that shows openness of the economy (OPEN)
Institutional Variables
Foreign investors, before undertaking any investment in a new country, always look into the degree of corruption in the economy. Many researchers have previously suggested that corruption is a big deterrent to the flow of FDI in Africa (Asiedu & Gyimah-Brempong, 2008). Therefore institutional quality as a measure for FDI flow needs to be done. For this research, two measures are employed for institutional quality – rule of law and control of corruption. The data is collected from Worldwide Governance Indicators (WGI) developed by World Bank (Kaufmann et al., 2010). The World Bank data on anti-corruption from different countries aim at improving governance and policy in different countries. We use this data to gather two institutional variables i.e. control of corruption (CORRUPTION) and rule of law (LAW).
Political Stability
According to the review of previous literature on FDI determinants, it is suggested that with political instability is a deterrent to FDI inflow. In this respect, we use the political stability (POLST).
Macroeconomic Factors
The macroeconomic factors that are considered in the process of understanding the determinants of FDI are market size and the capital formation that occurs due to the implementation of FDI. Market size can be determined through the understanding of the total market size of the region. This may be done by using the total population of the economy that would provide the market size of the economy. It can also be measured by GDP growth. In this research we consider three market size variable – population (POP), total nominal GDP as the measure of the country’s market (GDP) and GDP growth rate (GDPGRWT).
Macroeconomic stability is measured using measures of inflation (INFL) that is measures using percentage change in GDP deflator, gross capital formation as percentage of GDP (GCAP).
Another variable that affect the stability of the economy is the presence of foreign debt that would have an effect on the determination of foreign investment. This is measured using the foreign debt measure as a percentage of GDP (DEBT).
Another factor that is supposed to have a strong effect on FDI inflow is availability of a large labor force (skilled or not skilled). In this respect, we study the effect of labor force on FDI. For this, total labor force measure is taken as the variable (LAROR).
The effect of natural resources on FDI is a traditional idea that has been argued upon by most FDI researchers. With high amount of natural resource availability, there is expected to be a higher flow of FDI. In other words, foreign investors would be attracted to more availability of natural resources in the economy. Natural resources are therefore considered in assessing the determinants of FDI in SSA. Natural resources (NATURE) are measured as the percentage of export of oil and minerals from the countries.
Data Analysis
The equation is expected to be found out of the regression analysis conducted on the data is as follows:
FDI/GDP = α + β(Market Size) + θ(Policy Variables) + μ(Political Risk) + γ(Policy Variables) + ∞(GCAF) – μ(DEBT)
The analysis is done using fixed panel data using statistical data for 22 countries from 1990-2009. A few of the variables that are used in the research have high correlation, and therefore are used one at a time. As in case of human capital variable (LITERACY) and infrastructure variable (INFRA) have high correlation and thus, are used one at a time and not simultaneously. Further, the paper uses three measures of market size viz. population, GDP growth, and nominal GDP. Therefore in order to consider market size as a single variable we derive per capital GDP. Therefore per capital GDP is used as the measure for market size (MKTSIZE).
All the variables have set signs. When there is a large market, good policy, political stability, capital formation, FDI flow is expected to be high. The one to one regression between FDI and GDP shows that a unit increase in GDP would increase FDI by 2.74.
Descriptive and Correlation
The descriptive statistics shown in table 2 in the appendix demonstrates the mean, median, standard deviation, skewness, and kurtosis values of the data under study. On doing a correlation analysis (see table 3 in appendix) it is observed that there exists a negative relation between FDI and INFLATION as is expected out of the hypotheses. The relation between FDI and literacy is found to be positive and therefore indicates that with an increase in literacy, there would be a greater flow of FDI. Infrastructure too has a positive relation with FDI. Openness as opposed to the belief of previous studies shows a negative relation with FDI indicating with an increase in openness of an economy to trade, there is expected to be a decline in flow of FDI.
Corruption has a negative relation with FDI as expected, as there is expected to be a rise in FDI in countries where advent of corruption is low. Rule of law has a negative correlation with FDI, as there is greater rule of law, FDI is expected to be lower. This too goes against conventional beliefs of FDI literature. Political stability measured the degree of stability in the political system of a country. This is found to be negative, again refuting the conventional belief that with more stable political condition FDI flow will be greater. Higher capital formation is found to have a positive relation with FDI flow as there is expected to be a greater FDI flow in a region when there is greater capital utilization in the economy.
GDP growth, population, and GDP is found to have a positive relation with FDI, as it shows that bigger the market size of the economy, greater would be the flow of FDI. A bigger labor force attracts more FDI as indicated from the positive sign of the correlation of FDI with total labor force. External debt as a percentage of GDP (DEBT) has a negative relation with FDI. This indicates that higher is the indebtedness of a country, lower is the flow of FDI.
Regression
On running a regression on the policy variables i.e. inflation, infrastructure, literacy, and openness of the economy, we get a positive relation between FDI flow and literacy, and infrastructure. However, it shows a negative relation between FDI and openness and inflation. Therefore, the hypothesis that was taken that with an increase in inflation, FDI flow will reduce. The result is statistically not significant. Therefore, it can be stated that inflation does not play a strong role in determining FDI flow.
On doing a regression analysis on all the variables taking FDI to be the dependent variable, the following equation is derived. The regression analysis does not provide statistically significant results for all the variables at 95%. As the regression analysis does not provide a statistically significant result the regression analysis is refuted and another method of analysis is considered.
The results of the second regression with the variations are provided in table 4. The R-square value is 84 percent indicating a close to approximation of the regression result. Further, the ANOVA result also shows a statistical significance at 95 percent indicating a statistically significant result. The regression analysis provides the equation:
FDI = 1.97 – 0.0000001GDP – 0.03INFLATION + 0.0017LITERACY 0.12INFRA – 0.03OPEN – 9.11CORRUPTION +1.91LAW +7.64POLST +0.14GCAP + 40492DEBT +0.04NATURAL
The above equation indicates the coefficient of change in FDI is positively affected by changes in infrastructure, rule of law, political stability, gross capital formation, debt burden, and natural resources. The negative influences on FDI are GDP indicative of the market size, inflation, literacy, and corruption. The result therefore goes against the conventional belief that a large market size will definitely attract more FDI. As could have been observed in case of SSA, a higher GDP did not guarantee a higher flow in FDI. Therefore in case of the market size, it has a negative relation with FDI as shown in the regression analysis. A possible explanation for this is the global recession. With recession, the GDP of SSA reduced, however, the FDI flow remained high, and it increased vis-à-vis GDP. Therefore, recessionary pressure did not affect FDI flow even though it educed GDP of the economy. This is one possible explanation for a negative relation between FDI and GDP.
Inflation, literacy, infrastructure, and openness are policy indicators. This shows that as inflation increases, FDI flow will decline. This finding supports previous FDI researches. Further, it can also be stated that in case of SSA it indicates that a higher inflation in the economy will attract less FDI as higher inflation results in higher cost of production which would make the foreign investments less profitable. Literacy is found to have a negative relation with FDI. This finding does not support the conventional FDI research findings. However, if a regression analysis is done specifically between FDI and LITERACY it provides a positive coefficient, therefore indicating a positive relation. The result of the finding is also found to be statistically significant. Therefore, it can be said that literacy seems to have no definitive effect on FDI flow as the effect of the variable on FDI flow is found to be extremely low and erratic.
Infrastructure, as expected, has a positive relation to FDI flow. This indicates that with an increase investment in infrastructure and growth in roads, electricity, communication, etc. there is expected to be a greater flow of FDI. As in SSA, with better infrastructure the flow of FDI has increased.
Openness of the economy that had been calculated as the percentage change in net export of goods and services to nominal GDP shows that it has a negative effect on FDI. This implies, in SSA, when the economy showed greater openness in trade, i.e. when its exports exceeded its import, the flow of FDI declined. This is an unconventional result as it is believed that with greater openness of the economy, FDI flow would also increase. An alternative explanation for this finding may lie in the trade relations. As the foreign investors who invest in less developed or developing countries are mostly from developed countries, the governments of their country always want a strong trade relation with these countries. Therefore these countries would want higher imports in the developing world as they have a big market to offer. Therefore, with less import, the foreign investors, as a international political measure, reduce the flow of investment. This might be a possible explanation for a negative relation between openness and FDI.
Corruption is found to have a strong negative relation with FDI. If there is a unit increase in corruption index, FDI falls by 9.11. This indicates that foreign companies are very concerned with the level of corruption in the country when they consider investing in a foreign country. Further, rule of law has a positive relation to FDI. Therefore, adherence to law and regulation provides a positive signal to the investors. In case of SSA, corruption and rule of law have a strong influence on FDI as they are supposed to show the risk factors entailing entering the country.
Political risk factor plays an important role in SSA. In countries with higher degree of political stability, there is expected to be a greater flow of FDI. Political stability has a coefficient of 7.64 indicating a slight instability in the economy will reduce FDI by a multiple of 7.64.
Gross capital formation indicates the investment in capital formation and therefore in developmental activities especially in manufacturing, the countries where gross capital formation is higher will have higher FDI in SSA. Therefore, countries that already have a manufacturing base and have certain private infrastructure in place will attract more FDI.
Indebtedness in African nations is a recurring problem. However, the result with debt and FDI shows a positive coefficient indicating that more the indebtedness of an economy, greater is its ability to attract more FDI. This result cannot be rationally explained, and therefore, is not considered in further discussion. It can be stated the variable of indebtedness of an economy did not show any significant effect on FDI inflow of SSA.
The effect of natural resources on FDI flow in Africa has been conventionally been said to be a strong determinant. In present research with a greater availability of natural resources that is measured as export of oil and minerals from SSA showed a positive effect on FDI flow. Therefore, with greater natural resources, there is expected to be a greater flow in FDI.
Conclusion
FDI in SSA are mostly dependent on variables such as infrastructure, gross capital formation, law and regulation, political stability, and natural resources. The negative influences on FDI are GDP, literacy, corruption, and openness. The negative influences are found to be inconsistent with conventional literature. According to Loots (2000) the resources that drive the flow of FDI in an economy are the availability of cheap unskilled labor force, skilled labor, and the nature and worth of infrastructure. Therefore with the availability of abundant natural resources in Africa, a large amount of the FDI inflow should flow in the primary sector of the country. However, the present research found no significant relation between labor force and the flow of FDI.
Researchers like Asiedu (2006 ), Lim (2001) believe that a market seeking FDI will always look for a large buying market, or high income and income growth in the host country for investment. This is seen in case of countries that have a large GDP and population such that the investor can manufacture products and sell it in the local market. However, in case of SSA, market size seems to have a negative effect on the FDI flow. Therefore, refuting the findings of the previous studies.
Researchers have indicated that human capital is an important indicator of development in African countries (Suliman & Mollick, 2009; Mengistu, 2009). Therefore human capital in form of skilled and unskilled labor is expected to be big influencer in developing the FDI flow in the region. However, the present study demonstrates that literacy ahs a negative relation with FDI flow. The present study is inconsistent with the findings of the previous researches on FDI determinants of FDI.
Physical capital formation is found to have a strong positive effect on FDI flow (Mengistu, 2009). Gross capital formation increase has shown a higher growth in FDI. Therefore, with greater accumulation of physical capital, FDI flow is expected to increase. Therefore for policymakers this is an important consideration as with greater capital formation, the region can expect to attract greater amount of FDI.
Policy makers have to look into other areas too such as political stability and corruption. Previous research has shown that (Asiedu, 2006 ; Abdulai, 2007). Countries with greater corruption and higher political instability are expected to avoid by investors, as investment would become risky in the region. However, with greater political stability and less corruption, countries can attract more FDI. Therefore, policymakers must look into making the economy less corrupt and more politically stable.
Higher inflation actually implies that the fundamentals of the country are weak, and therefore, would attract less FDI (Onyeiwu & Shrestha, 2004; Asiedu, 2006 ). In another way, higher inflation can increase the cost of capital and production in the host country, therefore, making it an unattractive destination for the foreign company. The present study on SSA also indicates that inflation having a negative effect on FDI. Higher inflation in the economy raises the cost of production, and therefore, makes investment unprofitable. The policymakers should try to keep inflation under control as lower inflation is expected to attract more FDI.
Onyeiwu & Shrestha (2004) suggest that coutnries with better infrastructural facilites such as better roadways, uninterrupted water supply, and electricity would attract more FDI. Thus, a positive relation between FDI flow and infrastructure can be expected. In case of SSA it is observed that countries with better infrastructural facility attract more FDI. This finding is consistent with the prevalent literature. The recommendation for the policymakers is to concentrate on diverting the government expenditure on making better basic infrastructure like uninterrupted electricity supply, communication facilities, transportation, etc. therefore, with better infrastructural facilities, foreign investments are expected to flow more.
Therefore, the recommendation for the policymakers that can be derived from the present study is that they must concentrate on improving the infrastructure of the countries in order to attract more FDI. Further, capital investment on infrastructure and manufacturing is expected to provide a positive signal to the investors as to the manufacturing viability of the economy, and would, therefore, attract more FDI. From the institutional policy point of view a strong check on corruption and law and order must be kept. Any indication of higher degree of corruption or denial of legal justice or enforcement of law would make investors move away from investing in the country. Political stability in the region would play a strong factor in influencing FDI flow. In addition, in the end, natural resources of the economy would attract FDI. More the resources, greater is the flow of FDI. However, this a factor that cannot be controlled by the policymakers.
Appendix
Table 2: Descriptive Statistics
Table 3 Correlation Analysis
Table 4: Regression Analysis
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