Impact of FDI on economic performance in Africa: Part I

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Foreign direct investment (FDI) can be defined as “a category of international investment that reflects the objective of a resident in one economy (the direct investor) obtaining a lasting interest in an enterprise resident in another economy (the direct investment enterprise). The lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence by the investor on the management of the enterprise. A direct investment relationship is established when the direct investor has acquired 10% or more of the ordinary shares or voting power of an enterprise abroad”.

News Perspectives Prosper Chitambara

The notion of FDI does not necessarily imply total control of the domestic firm, as only a threshold of 10% ownership is required to establish a direct investment relationship. FDI comes in two basic forms namely: greenfield investments which involve the creation of new production processes and mergers and acquisitions (M&As) which involve the purchase of assets of existing local companies. FDI can also be classified according to its purpose, namely, natural resource seeking, market seeking, efficiency seeking and strategic asset seeking. Over the past few decades, there has been a significant increase in FDI flows on the African continent. FDI inflows into Africa have targeted the extractive sectors and have therefore been concentrated in a few resource-rich countries.

According to the 2014 Africa Economic Outlook, resource intense countries accounted for 65% of total FDI flows in 2013 down from 78% in 2008. The United States, United Kingdom (UK) and France accounted for 64% of total FDI stock in Africa in 2012, while the share of the Brics (Brazil, Russia, India, China and South Africa) in Africa’s total FDI stock rose from 8%in 2009 to 12% in 2012.

The share of FDI flows as a percentage of GDP provides an indicator of the significance of FDI in the economy. On the other hand, the share of FDI flows in Gross Fixed Capital Formation (GFCF) measures the importance of FDI in total domestic investment. FDI inflows as a percentage of both GDP and GFCF have grown considerably in Sub-Saharana Africa (SSA) since 1980.

In 1980, FDI accounted for only 0,09% of the continent’s GDP and by 2000 this figure had risen to 1,94%. In 2012, the share of FDI in GDP had risen to 3,29%.

Meanwhile, the share of FDI in GFCF rose from 0,5% in 1980 to 11,54% in 2000 and then to 16,39% in 2012. According to the 2014 Africa Economic Outlook, over the period 2001-2011 FDI, accounted for about 16% of GFCF in Africa surpassing the global average of 11%. Over the past few years, FDI inflows have become more diversified.

The growth in FDI flows into African countries has stimulated debate about the impact of FDI on economic performance. Economic theory highlights the importance of FDI in promoting economic development. FDI can generate positive externalities through providing financing, complementing domestic investment and enhancing competitiveness.

The role of FDI as a source of capital is particularly important for Africa owing to the prevailing huge financing gap and widening current account and fiscal deficits. This has been exacerbated by the low gross national savings and the binding budget constraint facing most African economies. Scholars such as Todaro and Smith (2003) argue that the inflow of FDI could fill the gap between the desired investment and domestically mobilised savings.

Moreover, since the majority of African countries do not have ready access to international financial markets they have to rely on alternative sources of finance which include FDI and aid.

Despite the huge increase in FDI and other capital flows, these resources have not had a meaningful impact on development in Africa. Moreover, FDI inflows to Africa have been volatile, concentrated in a few resource rich countries and targeting the extractive sectors. FDI in the extractive sector may have limited positive impact on growth because of the involvement of mega projects that often are not labour-intensive and do not utilise locally produced intermediate inputs.

A number of scholars have, however, questioned the role and sustainability of FDI. Turner (1991) explains that capital flows magnify current account disequilibria, with deficit countries confronted by capital outflows and surplus countries by capital inflows. Calvo et al. (1996) observe that the widening current account deficit is one of major problems associated with capital inflows.

United Nations Conference on Trade and Development (UNCTAD) (2002) reports that rising FDI inflows can affect the balance of payments because of profit outflows by multinational companies. Hsiao and Hsiao (2006) observe that FDI inflows have resulted in the development of an enclave economy. Bhinda and Martin (2009) note that FDI inflows in Africa are often surpassed by profits repatriated, raising questions about whether FDI is sustainable. Guerin (2012) argues that the unsustainable current account deficit is one of the undesirable effects of capital flows in developing countries.

Most African countries continue to experience high current account deficits, foreign exchange shortages and growing indebtedness. UNCTAD (1999) reports that for every US$1 transferred to developing countries in the form of FDI, around US$0,30 leaves in the form of repatriated earnings. Mold (2008) argues that once profit remittances are taken as a proxy for the price of FDI, FDI becomes an expensive form of financing.

The UNDP (2011), reports that total remitted profits and dividends from FDI in the developing world increased by about 736% from US$33 billion in 1995 to US$276 billion in 2008. The report also observes that profit remittances are increasing at a faster pace than FDI inflows, for instance, while profit remittances constituted about 29% of FDI inflows in 1995, by 2008 the figure had risen to 36%.

This study/thesis focussed on the impact of FDI on economic performance in selected African countries over the period 1980-2012. Firstly, I examined the link between FDI and domestic investment and the role of host country factors such as financial development, institutional development and trade openness.

Secondly, I investigated the impact of FDI on total factor productivity (TFP) and the role of relative backwardness (the technology gap) on a panel of 45 African countries over the period 1980-2012. Thirdly, I analysed the long run dynamic relationship between FDI, exports, imports and profit outflows in 47 African countries over the period 1980-2012.

This article is based on a PhD thesis by Chitambara submitted at the University of the Witwatersrand for the degree of a PhD (Economics). Dr Chitambara is a development economist with the Labour & Economic Development Institute of Zimbabwe (Ledriz). These New Perspectives articles are co-ordinated by Lovemore Kadenge, president of the Zimbabwe Economics Society. E-mail: kadenge.zes@gmail.com, cell +263 772 382 852

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