African Economic Conference 25-28 October 2011

Addis Ababa, Ethiopia

Revisiting the Determinants of Foreign Direct Investment in Africa: the role of Institutions and Policy Reforms

Gamal Ibrahim, Adam Elhiraika, Abdalla Hamdok (UNECA), Abbi Kedir (University of Leicester)

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Outline Objectives and Contribution of the Paper. Foreign Direct Investment In Africa. Determinants of Foreign Direct

Investment Flows to Africa. Data. Estimation and discussion of results. Conclusion and Policy recommendations.

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Motivation of the study

Increasing role of FDI as a source of investment and development in Africa and the changing global financial and economic architecture.

Rigorous empirical literature on determinants of FDI is still at early stages (Blonigen, 2005) and most existing work is statistically fragile (Chakarabarti, 2001).

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Contribution of the Paper Use of panel data to address Common

problems in the literature such as the unobserved country heterogeneity and the dynamics of the FDI process.

In addition to the standard variables in cross-country FDI regressions, the paper examines the impact of institutions and policy reforms on FDI Inflows to Africa.

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FDI Inflows to Africa

0100020003000400050006000700080009000

Eastern Africa Central Africa Northern Africa

Southern Africa

Average FDI Inflows in USD Millions to African Regions

1970-1990

1991-2009

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FDI Inflows as Share of the World

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FDI Inflows as Share of the World

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Classical Determinants of Foreign Direct Investment

The most influential motives for transnational corporations investing in developing countries have been market seeking and resource seeking (Dunning, 1998).

Dunning’s work has motivated a bulk of empirical literature on developing countries to pinpoint the main factors which hosts countries have to provide to secure FDI inflows (Wernick et al., 2009; Buckley., 2008; Bevan and Estrin, 2004, Blonigen, 2005).

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Policy reforms Determinants Literature

Focuses on the impact of business environment and trade and financial liberalisation.

Key determinant in the literature are:i) Inflationii) Exchange rateiii) Taxesv) Trade and Financial liberalisation.

'sound economic policies' as synonymous to 'austere' macroeconomic policies

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Role of Governance and Institutions Slow economic reforms imply that Africa is different. All else being equal, FDI is uniformly lower in Africa

due to weak institutions.

Few attempts to get beyond TC analysis.

Mixed empirical results on social development indicators as determinant of FDI.

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Data Our FDI data set along with the key

explanatory variables of interest are generated from GDF_WB (Global Development Finance of World Bank) and the period covered ranges from 1980 to 2009.

The panel data on Africa is merged with the institutional variables obtained from International Country Risk Guide (ICRG).

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Estimation and Discussion of Result Fixed effects model

Dynamic Panel GMM estimator

itititit uIxFDI 210

ittiit vu

ititititit uIxFDIFDI 2110

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Estimation results

Our empirical analysis is based on fixed effects model of net inflows of FDI expressed as a percentage of GDP.

Market size, corruption, domestic credit interacted by quality of bureaucracy, share of oil in exports and religious tension risk are significant drivers of FDI inflows in Africa

The result highlighted that FDI to Africa is market-seeking and follow oil economies.

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Estimation Results determinants of FDI flow to Africa,

underscore the adverse effect of weak economic governance and political instability as manifested in high levels of corruption and religious tensions.

Financial development, proxied by bank credit, is found to be conducive to FDI in the presence of quality bureaucracy.

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Conclusion and Policy Recommendations

African countries should undertake policies to expand local markets through regional integration.

Importance of credible institutional policy reforms that will improve economic governance and political stability, particularly by enhancing the quality of civil services, and combating corruption and religious tensions.

African countries must take effective measures to improve the quality of bureaucracy to ensure that financial development is conducive for FDI.

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Thank you!

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