Foreign Direct Investment in Africa and Its Determinants

U.S. Foreign Direct U.S. Foreign Direct Investment in Africa and its Investment in Africa and its

DeterminantsDeterminants

Emmanuel NnadozieEmmanuel NnadozieUna Okonkwo OsiliUna Okonkwo Osili

UNECA Workshop of Financial Systems and UNECA Workshop of Financial Systems and Mobilization in AfricaMobilization in AfricaNovember 2November 2ndnd 2004 2004

OutlineOutline

MotivationMotivation Central QuestionsCentral Questions Theoretical FrameworkTheoretical Framework DataData ResultsResults ConclusionsConclusions

MotivationMotivation

Foreign direct investment (FDI) represents an Foreign direct investment (FDI) represents an important source of finance for developing important source of finance for developing countries. countries.

Africa’s share of global FDI and US total Africa’s share of global FDI and US total

private investment to developing countries private investment to developing countries remains low and has not grown rapidly despite remains low and has not grown rapidly despite economic and political reforms.economic and political reforms.

BackgroundBackground FDI in Africa is relatively low, volatile, and highly FDI in Africa is relatively low, volatile, and highly

concentrated in a few countries.concentrated in a few countries.

For example, US FDI in Sub-Saharan Africa – mainly in the For example, US FDI in Sub-Saharan Africa – mainly in the manufacturing sector in South Africa, and the petroleum manufacturing sector in South Africa, and the petroleum industry in Nigeria and Angola. industry in Nigeria and Angola.

Foreign direct investment (FDI) in Sub-Saharan Africa yields Foreign direct investment (FDI) in Sub-Saharan Africa yields relatively high returns. In 2002: "The rate of return on FDI relatively high returns. In 2002: "The rate of return on FDI was highest in Sub-Saharan Africa, compared with other was highest in Sub-Saharan Africa, compared with other regions in the world, perhaps because, given perceived regions in the world, perhaps because, given perceived higher risks in the region, investors chose only high-return higher risks in the region, investors chose only high-return projects.” (World Bank, 2003). projects.” (World Bank, 2003).

Figure 1. Africa : FDI inflows, top 10 countries, 1999 and 2000* (Billions of dollars)

Source : UNCTAD, World Investment Report 2001. * : Ranked on the basis of the magnitude of 2000 FDI inflows.

Figure 1. Africa : FDI inflows, top 10 Figure 1. Africa : FDI inflows, top 10 countries, 1999 and 2000* countries, 1999 and 2000*

(Billions of dollars)(Billions of dollars) –source UNCTAD –source UNCTAD

FDI and Remittances: A FDI and Remittances: A comparisoncomparison

In 2002, foreign direct investment In 2002, foreign direct investment remained the most important source of remained the most important source of external financing for developing external financing for developing countries, with net FDI reaching $143bn in countries, with net FDI reaching $143bn in 2002. 2002.

Workers' remittances –currently the Workers' remittances –currently the second largest source of inflows $80bn second largest source of inflows $80bn last year, up from $60bn in 1998, while last year, up from $60bn in 1998, while net lending by official creditors to net lending by official creditors to developing nations was $16bn, with developing nations was $16bn, with another $33bn given in grants. another $33bn given in grants.

Country ExamplesCountry Examples A few examples from Sub-Saharan Africa: A few examples from Sub-Saharan Africa:

DATA from IMF’s, DATA from IMF’s, International Financial International Financial Statistics yearbook various yearsStatistics yearbook various years

SUDANSUDAN Workers' remittances averaged 417 Workers' remittances averaged 417 million dollars in 1995-98,representing over 70% million dollars in 1995-98,representing over 70% of export earnings and three and a half times the of export earnings and three and a half times the amount of foreign direct investment (FDI).amount of foreign direct investment (FDI).

NIGERIANIGERIA Workers' remittances received on Workers' remittances received on average in 1995-98 were over 1.3 billion dollars, average in 1995-98 were over 1.3 billion dollars, 10% of the value of exports and roughly equal to 10% of the value of exports and roughly equal to the total of FDI. the total of FDI.

MALIMALI At 103 million dollars, workers' remittances At 103 million dollars, workers' remittances on average in 1994-97 were equivalent to 23.3% on average in 1994-97 were equivalent to 23.3% of export value and were greater than FDI.of export value and were greater than FDI.

Central QuestionsCentral Questions

What are the economic and political What are the economic and political variables that influence FDI flows to variables that influence FDI flows to Africa? Africa?

How do US FDI flows differ from total How do US FDI flows differ from total

FDI flows to Africa? FDI flows to Africa?

Theoretical FrameworkTheoretical Framework

US FDI = f (GDP, US FDI = f (GDP, economic economic growth growth rate, openness, infrastructurerate, openness, infrastructure quality quality, , inflationinflation, , political riskpolitical risk,, labor force labor force quality)quality)

US FDI =US FDI = + + β1β1GDP + GDP + β2β2economic economic growth + growth + β3β3OPEN + OPEN + β4β4TELEPHONES + TELEPHONES + β5β5CPICHANGE + CPICHANGE + β6β6POLITICALRISK + POLITICALRISK + β7β7ENROLLEMENTS + ENROLLEMENTS + μμ

DataData

World Bank World Bank African Economic African Economic IndicatorsIndicators

US Commerce DepartmentUS Commerce Department -US -US Direct Investment DatabaseDirect Investment Database

PRS GroupPRS Group, International Country , International Country Risk GuideRisk Guide

Penn World TablesPenn World Tables

Figure 1.Figure 1. Total Annual US Direct Investment in Africa Total Annual US Direct Investment in Africa 1982-1982-20012001, in , in millions of millions of Current US DollarsCurrent US Dollars

0

10000

20000

30000

40000

50000

60000

1985 1990 1995 2000 1982

Key DefinitionsKey Definitions

The U.S. direct investment includes the The U.S. direct investment includes the acquisition of sufficient common stock in a acquisition of sufficient common stock in a foreign country, the acquisition or foreign country, the acquisition or construction of plant and equipment in a construction of plant and equipment in a foreign country, U.S. parent companies’ foreign country, U.S. parent companies’ equity in, and net outstanding loans to equity in, and net outstanding loans to their foreign affiliates.their foreign affiliates.[Note][Note] A foreign affiliate is a foreign A foreign affiliate is a foreign business enterprise in which a single US business enterprise in which a single US investor owns at least 10 percent of the investor owns at least 10 percent of the voting securities, or the equivalent. voting securities, or the equivalent.

Econometric IssuesEconometric Issues

Omitted Variable bias (some investor Omitted Variable bias (some investor and host country policies may be and host country policies may be unobserved in our analysis)unobserved in our analysis)

Measurement error Measurement error Multicollinearity (GDP growth may Multicollinearity (GDP growth may

affect infrastructure, political risk, affect infrastructure, political risk, labor quality, and other explanatory labor quality, and other explanatory variables).variables).

Economic VariablesEconomic Variables

Real per capita GDP---market sizeReal per capita GDP---market size Real GDP growthReal GDP growth Openness to International Trade—Openness to International Trade—

ratio of sum of exports to importsratio of sum of exports to imports Inflation (Change in CPI)Inflation (Change in CPI) Labor Force Quality (literacy rate, Labor Force Quality (literacy rate,

primary school enrollments)primary school enrollments) Infrastructure quality-number of Infrastructure quality-number of

telephone lines per capitatelephone lines per capita

Measuring Political Risk Measuring Political Risk

Political Risk Indicator: International Political Risk Indicator: International Country Risk Guide RatingCountry Risk Guide Rating

Political instability has been shown to have Political instability has been shown to have a negative effect on foreign direct a negative effect on foreign direct investment in cross-country regressions investment in cross-country regressions (Schneider and Frey, 1985). (Schneider and Frey, 1985).

Since 1960, more than 40 percent of Since 1960, more than 40 percent of African countries have experienced at African countries have experienced at least one civil war (Collier and Hoeffler, least one civil war (Collier and Hoeffler, 2002). --- may pose substantial barriers to 2002). --- may pose substantial barriers to FDI inflows to the region. FDI inflows to the region.

Summary StatisticsSummary Statistics

Variables N Mean Median Standard

Deviation Minimum Maximum

Log GDP per Capita 33 6.241 6.049 1.013 4.633 8.406

Real GDP Growth 33 0.241 0.483 2.521 -7.712 4.944

Openness 34 0.636 0.576 0.264 0.261 1.357

Infrastructure (Log telephones per capita) 36 1.956 1.573 1.292 -0.315 4.596

Inflation Rate 33 201.267 10.589 911.834 3.376 5210.914

Political Risk Index 35 53.141 54.6 12.309 25.25 77.714

Literacy 31 56.921 58.9 18.579 13.225 84.4

Primary School Enrollments 34 85.523 93.152 32.293 28.733 162.58

Political RiskPolitical Risk Political Risk may pose barriers for US FDI in Political Risk may pose barriers for US FDI in

Africa? Africa?

Interesting context:Interesting context: High concentration of FDI High concentration of FDI flows in the primary resource extraction sector flows in the primary resource extraction sector may lead to an unclear relationship between may lead to an unclear relationship between

Some evidence from Latin America -- political risk Some evidence from Latin America -- political risk was not found to be a significant factor in the FDI was not found to be a significant factor in the FDI location decision (Trevino et al , 2002). location decision (Trevino et al , 2002).

Main FindingsMain Findings

Total FDI –appears more responsive to Total FDI –appears more responsive to economic and political variables than US economic and political variables than US FDI.FDI.

Political Risk has a a significant, negative Political Risk has a a significant, negative impact on total FDI and FDI as a share of impact on total FDI and FDI as a share of GDP, less clear for US FDIGDP, less clear for US FDI

GDP growth rate, literacy, and Openness GDP growth rate, literacy, and Openness have a positive and significant impact on have a positive and significant impact on total FDItotal FDI

Other FindingsOther Findings

Less robust evidence on the role of Less robust evidence on the role of GDP per capita and infrastructureGDP per capita and infrastructure

Inflation rate has a negative effect on Inflation rate has a negative effect on FDI inflows, but less robustFDI inflows, but less robust

ConclusionsConclusions

There is still a considerable There is still a considerable proportion of the variation in total proportion of the variation in total FDI and US FDI and US FDI FDI not explained by the not explained by the model. model.

Other potential explanations: bias Other potential explanations: bias toward Africa or by a lack of toward Africa or by a lack of information and knowledge about information and knowledge about African business opportunities? African business opportunities?

Future WorkFuture Work

Need to study the effect of changes in Need to study the effect of changes in wages, monetary and exchange rate wages, monetary and exchange rate policy, taxation and other variables that policy, taxation and other variables that may influence FDI flows for several African may influence FDI flows for several African countries. countries.

Institutions, government policies, Institutions, government policies, geography, ethnic diversity, and other geography, ethnic diversity, and other factors that may be difficult to capture factors that may be difficult to capture within a regression framework. within a regression framework.

POLICY IMPLICATIONSPOLICY IMPLICATIONS

A number of countries have undertaken A number of countries have undertaken economic and political reforms in Africa, economic and political reforms in Africa, but has not led to a significant expansion but has not led to a significant expansion in US FDI to the region.in US FDI to the region.

In a competitive global economy, it is not In a competitive global economy, it is not enough just to improve one's policy enough just to improve one's policy environment: improvements need to be environment: improvements need to be made both in made both in absoluteabsolute and and relativerelative terms – terms –(Asiedu, 2004). (Asiedu, 2004).