Working Paper 136 - Determinants of Foreign Direct Investment Inflows to Africa, 1980-2007
AbstractThis paper examines the factors that determine FDI flows to African countries. FDI plays an important role in Africa’s development efforts, including: supplementing domestic savings, employment generation and growth, integration into the global economy, transfer of modern technologies, enhancement of efficiency, and raising skills of local manpower. In the context of falling foreign aid due to the recent financial and economic crisis, as well as the current Euro-debt crisis, a detailed analysis of the aid-FDI nexus in the development cooperation relationship is indeed an enriching and useful exercise. Africa has never been a major recipient of FDI flows and lags behind other regions of the world. After almost ten years of growth, FDI inflows to Africa fell from a peak of US$72 billion in 2008 to $59 billion in 2009 - a 19 percent decline compared to 2008 - due to the financial and economic crisis. By 1990, Africa’s share of global total FDI was a mere 1.37 percent compared to Asia’s 10.9 percent and by 2009 while Africa’s share was just 5.27 percent, Asia received 27 percent. Just as FDI inflows to Africa represent a low percentage of the global total, they also represent a low percentage of its GDP and gross capital formation. A major concern regarding FDI inflows into the Continent is that the overwhelming majority of these go into natural resources exploitation. Between 1998 and 2009, the top ten country recipients are Egypt, South Africa, Nigeria, Sudan, Angola, Congo Republic, Morocco, Tunisia, Algeria, and Chad. Of these top recipient countries, most of the flows into oil, gas and mining projects. Indeed, the primary sector has been the largest recipient of accumulated FDI outflows to Africa. For example, the distribution of FDI by industry shows a concentration in the mining industry in terms of value In the analysis, we perform pooled ordinary least squares (OLS) estimations and feasible generalized least squares (FGLS) for the cross-sectional time-series linear model, using country level data. For robustness check, we take cognizance of the view that FDI decision may be made based on historical data and hence use a one-period lag of independent variables for re-estimation by OLS/FGLS. For further robustness check and to take care of any possible endogeneity in the aid variable, we also estimated the data using the two-step (IV) efficient generalized method of moments (GMM). Our estimation results from cross-country regressions for the period 1996-2008 indicate that: (i) there is a positive relationship between market size and FDI inflows; (ii) openness to trade has a positive impact on FDI flows; (iii) higher financial development has negative effect on FDI inflows; (iv) the prevalence of the rule of law increases FDI inflows; (v) higher FDI goes where foreign aid also goes; (vi) agglomeration has a strong positive impact on FDI inflows; (vi) natural resource endowment and exploitation (such as oil) attracts huge FDI; (vii) East and Southern African sub-regions appear positively disposed to obtain higher levels of inward FDI. The result suggests that African countries that receive high level of foreign aid also receive high levels of FDI flows. A good reason for this is the positive “infrastructure effect” by which aid improves African countries’ economic and social infrastructure and hence raising the marginal product of capital in those countries. The study finds that FDI is negatively correlated with financial development. African countries should improve the quality of domestic financial systems (including integrating them into global financial markets) to make it more attractive to invest there. Moreover, enhanced regional cooperation and integration will increase market size in Africa and help attract investors. This is all the more important given our finding that large market size attracts FDI to Africa. Good governance infrastructure and institutional quality, especially the rule of law, attract FDI to Africa. They also create conditions for the emergence of domestic conglomerates.
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