North Africa - Working paper - Does foreign direct investment improve welfare in North African countries?

This paper examines the relationship between FDI inflows and welfare improvement in North African countries. Using net per capita FDI inflows and the UNDP’s HDI as the principal variables, our analyses confirm the positive and strongly significant relationship between net FDI inflows and welfare improvement in North Africa, although we do find significant differences among the countries in the region. This relationship holds even after we control for government size, country indebtedness, macroeconomic instability, infrastructural development, institutional quality, political risk, openness to trade, education and financial market development. Hence, at the aggregate level, FDI contributes to economic growth in North Africa, in turn generating additional revenues for governments and populations in the region through fiscal policies and jobs creation. It is therefore essential for governments in the region to continue investing in social infrastructures while improving the quality of their institutions and their governance; doing so will help avoid the type of unrest we have witnessed recently. We also found that FDI received by countries in the region are mainly concentrated in very few industries (particularly extractive petroleum, services and tourism, construction and utilities); relatively fewer of these investments are directed toward the non-extractive primary industries, which are pro-poor sectors and highly labor intensive, or the manufacturing sector, with a high potential for spillover effects in the economy. This lack of diversification of FDI received in the region’s economies in part explains the differences observed in the link between FDI and welfare in these countries.Three main policy recommendations are formulated. First, in terms of reducing differences in average welfare between countries in the region, policies to attract FDI should be carefully designed to direct those investments toward the most productive sectors of the economy, namely the manufacturing sector. Second, in terms of reducing inequalities within a country, sufficient incentives should be provided to encourage foreign investments in labor-intensive and pro-poor sectors such as agriculture, fishing, education, health and infrastructural development. And lastly, in order to better redistribute wealth within the region, reduce poverty and improve human development, governments in the region need to improve the quality of their institutions and their governance.