Overall, the analysis showed that there is a negative relationship between foreign direct investment (FDI) and domestic investment in African economies. While the negative correlation may suggest that FDI has a crowding-out effect it could also equally imply that countries with lower private investment attract FDI because there are more domestically unsatisfied opportunities for foreign investors (e.g. because of resource endowments requiring foreign expertise).
More importantly, this negative relationship between FDI and domestic investment does not necessarily imply that FDI has no positive effects on growth or that it is not needed. It may as well be that the positive benefits from FDI in African economies may be as a result of an increase in total factor productivity (TFP) which more than compensates for the decline in domestic investment.
FDI’s growth-enhancing impact can only be realised when it stimulates the absorptive capacity of the host country.
The study found that improved institutions do mitigate the negative effects of FDI while financial market development exacerbates the negative effects of FDI on private domestic investment. This implies that there is a need to develop policies to strengthen institutions.
The review of the literature also suggests that African countries will benefit from measures aimed at promoting private domestic investment. My results also showed a general positive but insignificant effect of FDI on productivity growth in African countries under the sample. This suggests that FDI has a limited effect on productivity in African countries. These findings support previous studies that have questioned the widespread enthusiasm associated with FDI (e.g. Carkovic and Levine, 2005; Aitken and Harrison, 1999). The failure by many African countries to fully adopt foreign technologies may be because of the limited absorptive capacity. Blomstorm and Kokko (2003) observe that spillovers from FDI are not automatic and that they depend on local conditions. In particular, Borensztein et. al. (1998) and Xu (2000) show that FDI is more productive than domestic investment only when the host economy has sufficient human capital development.
An analysis on the impact of FDI on exports, imports and profit outflows in 47 African countries over the period 1980-2012 showed that a long run relationship exists between the variables. These findings provide evidence on the adverse long run effects of FDI on the current account in African economies. In particular, the results show that, FDI inflows lead to a decrease in exports and an increase in both imports and profit remittances. This confirms that profit outflows by multinational companies are one of the main factors driving current account deficits in African countries.
African countries should therefore develop policies to improve local conditions, strengthen institutional quality and enhance trade openness. African governments should focus more on improving the education and skills level of the labour force through human capital investments.
Hence, as argued by (Ashraf et al, 2014), finite domestic government resources could probably be better utilised in human capital investments as opposed to offering tax and other non-tax incentives to multinational companies.
Empirical evidence shows that institutions help in the diffusion of technology and countries with better institutions tend to experience better technology diffusion and that those countries lacking basic institutions experience difficulties in absorbing foreign technology (Manca, 2009). African governments should strengthen their institutions so as to improve their absorptive capacity and thereby close the technology gap.
Policy efforts aimed at attracting FDI should be balanced with the imperative of strengthening domestic firms, entrepreneurship and local innovation. Keshava (2008) has demonstrated that even in those countries where FDI has been more productive and beneficial, domestic investment is more effective than FDI in promoting growth. Investment incentives should not discriminate against domestic investment. Policymakers should therefore implement policies that strengthen the linkages between FDI and the local industry. Importantly, the objectives of multinational corporations need to be synchronised with the development imperatives and goals of African countries. Regional integration needs to be expedited in line with the recommendations from UNCTAD (2005), which notes that African countries need to think regionally. Market and competition regulations to dismantle the monopolistic tendencies of some foreign investors should be strengthened in many African countries.
The continent must adopt a targeted approach to FDI. As Alfaro and Charlton (2007) argue, some types of FDI may be more beneficial and productive than others. Agosin and Mayer (2000) note that the reason why FDI has been more productive in Asia than in other developing countries is because of the cautious and targeted approach.
In addition, Adams (2009) observes that this approach should involve careful screening of investment projects and granting differential incentives to investments in different sectors. While FDI inflows in African countries have mainly been concentrated in the extractive sector, in most Asian countries FDI has largely been focused towards the secondary sector, thereby contributing to the diversification of the export base (UNCTAD, 2007).
African policy makers should therefore seriously consider the prioritisation of FDI to sectors such as manufacturing so as to diversify growth and the export base.
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: firstname.lastname@example.org, cell +263 772 382 852.