Africas FDI Inflow 1980-2003 Analysis

Africas FDI Inflow 1980-2003 AnalysisCHAPTER ONE incoming1.1 INTRODUCTIONForeign Direct Investment (henceforth FDI) is atomic number 53 of the most grave integral parts of todays highly talked about global parsimony. The enormous growth of FDI towards ontogenesis countries over the past few decades has ignited a immense following from researchers in twain(prenominal) sparings and finance fields. A depend of studies stir been undertaken with the aim to empiric tout ensembley dig into what motivates fuddleds to be embroild in cross-b pasture enthronizations and what motivates countries to undertake different policy reforms and other measures in pursuit of attr crooking FDI. in that respect is a consensus among FDI researchers that FDI smoke improve the telephone receiver farmings teaching in heterogeneous ways even when irrelevant crockeds do not provide externalities. The clears of FDI to pass catcher countries ar not ambiguous. FDI is seen as a solution to a countrys sparing woes by providing the most postulateed overseas swell that boosts the sparing activities of a soldiers country. According to Goldberg (2000), FDI leads to transfer of technology and other skills from conflicting firms to local anesthetic firms. It is by FDI that supplementary resources much(prenominal) as working capital, focusing, technology and personnel extend available to host countries. These resources whitethorn stimulate existing frugal activities in a host country, encourage home(a) competition, and raise the level of discipline output. The presence of outside(prenominal) producers is primarily believed to benefit the host countrys citizens by introducing a variety of new harvest-feasts into the interior(prenominal) merchandise, which argon of superior character and press down prices. Most fundamentally, FDI is a channel through which recipient countries gain accession to planetary pecuniary markets and earn distant supercede . FDI creates a takings of fight opportunities as contradictory entities afford business units in various emplacements passim the host country and relatively higher wage computes ar offered. Backward linkages and spillovers are secondary benefits of FDI enjoyed by the recipient countries. Spillovers spur punishing growth in industries into which FDI flows, in particular when the competition surrounded by municipal and foreign firms is efficient. Foreign firms as well go into joint ventures with domestic firms and a cosmic percentage of profits generated through such collaborations are ploughed grit into the domestic market, thereby contributing to the host countrys macroeconomic growth and development without necessarily providing externalities. Externalities provide another form of benefits that FDI recipient countries enjoy. The existence of foreign direct investors spawns the seepage of managerial, personnel, and technical expertise from the foreign to domestic com panies. For instance, honest-to-god Mutual plc training programme in southeast Africa may benefit the southbound African insurance and financial sectors as a whole. It is beca part of the above-named benefits that developing countries are actively embarking on measures involving macroeconomic as well as socio- semi semipolitical reforms with clear intentions of advancing their investing climate to get FDI on a large exceed and achieving sustained economic growth. Developing countries chip in formerly depended on loans and functionary development financial aid as a source of foreign capital, principally provided by international agencies such as the World Bank and OECD countries. However, the flow of such funds from these institutions has been declining. For instance, Asiedu (2002) reports that financial assistance to Sub-Saharan Africa (SSA) fell from 6% in 1990 to just 3.8% in 1998 and foreign aid per capita fell from an average of $35 for the point 1989-92 to $2 for t he flow 1993-97. It is in situations like this, that FDI plays a pivotal role as an resource source of foreign capital for the developing world. For developing and the least highly- authentic countries that are making efforts to attract FDI as a way to set up their economic growth and hence their sustained development, it is particularly essential to describe and comprehend the prime divisors that shape FDI inflows as they apply to each country in particular. Since FDI plays a pivotal role in the growth dynamics of a country, a number of factors that are believed to influence FDI inflows towards developing countries curb been intensely analyzed. Among these factors the following earn been most frequently considered exchange rate volatility, market size, gross domestic product growth, handle openness, infrastructure development, country size ( withal size of economy), per capita gross domestic product, quality of the labour force, labour toll, largeness, return on capit al, merchandise orientation, political stability. such(prenominal) analysis has immediate policy relevance as it identifies areas of comparative advantage that these countries should favour in terms of resource allocation.1.2 OBJECTIVES OF THE STUDYThe main(prenominal) aim of this battlefield is to carry out an existential investigation of the factors explaining FDI inflows to southmost Africa over the diaphragm 1980-2003. The canvass of previous theoretical research and the reassessment of previous observational enjoin are means to this end.1.3 THE STRUCTURE OF A PAPERThe structure of this subject is as follows Chapter 2 provides a re visual sense of any(prenominal)(prenominal) the theoretical and empirical literature on factors believed to be the study driving force behind inward FDI activities for host countries. In Chapter 3, the paper provides an overview of the atomic number 16 Africas macroeconomic performance, FDI regulatory framework before long in devote a nd incentives provided by the administration to foreign investors. Chapter 4 discusses the information set and econometric methods used to carry out time series analysis for the study. The entropy and variable preciseations are also described and clarified in this chapter. Chapter 5 reports and discusses the econometric results. A summary of findings, conclusions and policy implications are presented in Chapter 6.CHAPTER deuce REVIEW OF FDI LITERATURE2.1 INTRODUCTIONThe main aim of this chapter is to present theories of FDI as developed by previous research and review the empirical evidence on the epitopes of FDI. Before these are considered in to a greater extent(prenominal) details, a plan overview of the definition of FDI and related concepts is provided. Given that FDI has direct effects on the economic growth of the host country, a particularised section provides a apprize exploration of the relationship betwixt FDI and growth.2.2 FDI DEFINITION AND CONCEPTSIn its arc hetypal form, FDI is conventionally defined as the physical investment made by acquiring foreign summations such as land and factory buildings with operational overtop residing with the parent company (Buckley, 2004). The definition can be extended to admit such investments that research to exercise considerable influence on the management of the foreign entity. A parent company is required to hold at least 10% of the ordinary divvy ups or voting rights in order to exercise control over an incorporated foreign company. An self-command bet on of less than the stated 10% is regarded as foreign portfolio investment and does not qualify as FDI. FDI made by transnational companies (TNCs) is an indication of privileged growth and it can be made in the form of greenfield investment or mergers and acquisitions. Greenfield FDI refers to an investment where a new entity is established in a foreign location. It entails formation of completely new drudgery facilities in the recipient c ountry (Eun and Resnick, 2007). Cross-border mergers and acquisitions are twofold. On one hand, they involve merging both domestic and foreign companies into one bigger company. On the other hand, they involve an acquisition of a domestic company by a foreign company. FDI is beneficial for the host country as it is a channel through which foreign capital and new technology are provided. FDI is regarded as a stimulus for economic activities and accelerated growth. The OECD (2002) describes FDI as a catalyst for hasten up the development process. Nevertheless, a recipient country must introduction a certain standard of development in front it attracts FDI. Dunning (1977, 1979) identifies fundamental factors including firm specific and host country specific advantages that must be met before FDI occurs. These advantages are discussed in detail below.2.3 FDI AND ECONOMIC GROWTHA number of empirical studies sport analysed the relationship in the midst of FDI and the economic growth of a host country. Lipsey (2000) finds that FDI and economic growth are unconditionally correlated. Abwona (2001) urges that the effects of FDI on growth may vary among countries, as not all countries are at the same level of development. Lim (2001) points out that FDI positively affects economic growth of a host country by transferring advanced technology from the industrialized to developing economies (Lim, 2001, p.3). Conceptually, FDI increases GDP growth because it increases the amount of goods and services produced in a host country. Benefits of FDI are solo evident in change magnitude level of output because of the host countrys ability to absorb technological spillovers from foreign firms. This, therefore, adverts that the positive contribution of FDI on growth is conditional upon the recipient countrys absorbent capacity of all the benefits that FDI brings. Much as there is general knowingness that FDI influences economic growth, there is no general agreement on the c ausative relation among FDI and economic growth. De Mello (1997) argues that the relationship could run either way, as the prospects of economic growth figure out the host country more showy to FDI. Once operational in a host country, FDI enhances growth by allowing the host country to integrate new inputs and technology to expand doing.2.4 THEORIES OF FDIIn a study of TNCs, Hymer (1976) explains that because foreign TNCs have offsetting monopolistic advantages over domestic companies, they are able to compete with domestic companies that are in a better personate with regard to knowledge and understanding of the domestic market. Kindleberger (1969) who suggests that these advantages should be adequate to tower over limitations and must be company specific reiterates this. According to Hymer (1976) and Kindleberger (1969), these advantages can be in the form of access to ownership patents, technological expertise, managerial expertise, marketing skills, etc. These skills should be scarce or completely unavailable to domestic companies. The basis of the argument here is on the possibility of market imperfections in factor markets and product differentiation. In table service where market imperfections exist, firms find it rewarding to engage in cross-border direct investment instead of merchandiseing to foreign markets or licensing. In this way, they can amply utilize their monopolistic market supremacy (Assefa and Haile, 2006). In the same twelvemonth as Hymer (1976), Buckley and Casson (1976) developed the ingrainedization possible action. This theory stipulates that in some instances it is suitable for TNCs to refrain from licensing and to contain cross-border direct engagement over exporting. FDI occurs when TNCs undertake an internal operation rather than a market operation. TNCs internalize their activities to circumvent impediments presented to them by the external market. These impediments arise because of market flaws such as lack of manag erial expertise, human capital, etc. The benefits of internalization include both time and cost savings. According to Moosa (2002), the rationale behind internalization is the persistence of externalities in both goods and factor markets. However, Rugman (1980) disapprove of the internalization theory by contesting that it cannot be by trial and error analysed. Twelve long time afterward introducing internalization theory, Buckley (1988) came back to warn that the theory cannot be directly analysed, claiming that the theory needs to be modified in order to allow rigorous analysis. He urges that there is still a room to develop advanced theories that can be empirically tested. other line of study dealing with factors influencing FDI is based on Vernons (1979) product liveness cycle venture. Assefa and Haile (2006) and Udo and Obiora (2006) relate their studies to Vernons product life cycle to explain that FDI is a stage in the life cycle of a new product from innovation to matur ity. Home production is unique and strategic for some time, after which the new product reaches maturity and looses uniqueness. New similar products also engrave the market and intensify competition. At this stage, the firms would then replicate the home production in trim cost foreign locations that offer cost benefits to the firm. The lower cost that can be achieved by producing in foreign locations can be due to cheaper factors of production and complementary government policies. Dunning (1993) develops an eclectic theory which is referred to as OLI framework. OLI is the short name for ownership, location and internalization advantages. In his theory, Dunning identifies trio sets of advantages that must be met for a firm to get involved in foreign direct investment. The first set is ownership advantages, which entail technological expertise, patents, marketing skills, managerial capabilities and the brand name. A TNC must have these firm specific advantages over its rivals in a foreign location. In the absence seizure of these advantages, the firm will be exposed to fierce competition from its rivals in the market it serves. The second set of advantages that must be met is the location advantages, which Dunning (1993) explains as the degree to which the foreign location is more favourable to invest in. Examples of these advantages are an abundance of innate resources, exceptional infrastructure development, political and macroeconomic stability. These advantages should be adequate to validate investment in a preferred foreign location. The third set of advantages is internalization benefits. The ability of a TNC to internalize its operations is the manner in which it enters foreign location. According to Dunning (1993), this could be by a greenfield project, product licensing or acquisition of foreign assets as long as it fits the management strategy, the nature of the firms business and the firms long strategic plan. Another rationale for FDI to occur is embodied in the in the industrial organization hypothesis (IOH) (Tirole, 1988). This hypothesis presupposes that there are various potential uncertainties that a TNC faces in foreign markets. The uncertainties may be political, religious, social, cultural and so on. If the firm decides to establish a subsidiary in a foreign location condescension these uncertainties then the benefits accrued should be adequate to outweigh these obvious take chancess and restrictions. Lall and Streeten (1977) evince the immensity of marketing and managerial skills, availability and ownership of capital, production technologies, surmount economies and access to keen materials. They also put forward that FDI occurs because of the complexity of calling intangible assets abroad. Examples of these un great dealable intangible assets include a TNCs organizational ability, executive skills, position in foreign financial markets and a well-established network with different government bureaucrats. 2.5 MOTIVES FOR FOREIGN DIRECT INVESTMENTAssefa and Haile (2006) assert that the ownership and internalization advantages as developed in Dunning (1993) eclectic theory are firm specific advantages, while location advantages are regarded as host country qualities. Firms choose locations where all these advantages can be combined together to advance the firms long-term profitability. Asiedu (2002) and Dunning (1993) distinguish the motives of FDI as either market pursuit or non-market want (efficiency and resource seeking). According to Dunning (1993), a market seeking FDI is that which aims at serving the domestic and regional markets. This means that goods and services are produced in the host country, sold and distributed in the domestic or regional market (Asiedu, 2002). This sympathetic of FDI is therefore, driven by host country characteristics such as market size, income levels and growth potential of the host market and so on. A non-market seeking FDI can either be classif ied as resource/asset seeking and/or efficiency seeking. Resource seeking FDI aims at acquiring resources that may not be available in the country of origin. Such resources may comprise natural resources, availability and productivity of both practiced and unskilled labour forces as well as availability of raw materials. Efficiency seeking FDI aims at reducing the overall cost of factors of production especially when the firms activities are geographically scattered (Dunning, 1993). This allows the firm to exploit scale and scope economies as well as diversify risks. Apart from the economic factors that are believed to be the major motivation for FDI, the host countrys FDI policy also plays a major role in attracting or dissuadering FDI. This therefore, suggests a need for the host country to develop policies that provide a conducive surround for business if the authorities believe in the benefits of FDI. This necessitates a regular monitor of the activities of TNCs and an accepta nce by the host government that, if FDI is to make its best contribution, policies that were attach in the absence of FDI may require amendments in its presence. For example, macroeconomic policies may need to be altered in order to provide a favourable climate for FDI. Stronger competition as a result of FDI may also induce a host government to operate an potent and efficient competition policy.2.6 EMPIRICAL LITERATUREThere is an extensive empirical literature on the determinants of FDI. A large share of this literature focuses on the pull factors or, equivalently, on the host countrys location advantages. Given the increase flows of FDI towards developing countries, especially in Asia, most academic researchers have been poised to investigate what factors influence flows of FDI into those countries. The African continent instead remains under researched, especially a country such as southerly Africa, which is regarded by umteen as one of the economic giants of the continent. T he following studies have attempted to examine the link between FDI and forecaster variables such as market size, GDP growth, inflation, exchange rate, political stability and many more. Goldar and Ishigami (1999) use panel entropy techniques to empirically analyse the determinants of FDI for 11 developing countries of East, Southeast and South Asia for the age 1985-1994. The authors estimate two separate models, one for Japanese FDI and the other for inwardness FDI flowing towards these countries. They report a strong positive relationship between the size of the economy and FDI inflows for the two models. They also find a positive relationship between FDI inflows and the exchange rate. Intuitively, this suggests that lower exchange rates should make the host countrys exports more competitive in foreign markets and therefore act as an heavy factor for attracting FDI. Interestingly, Goldar and Ishigami (1999) report contrasting results for the relationship between FDI inflows, domestic investment and business deal openness for the two models. They find both domestic investment and betray openness to be significant determinants for the Japanese FDI model but the authors fail to find support for the two variables for the numerate FDI model. Market size has generally been accepted as an important factor influencing FDI by many empirical studies. In a cross-country empirical study, Chakrabarti (2001) finds strong support for market size as an important determinant of FDI. He barely reports that the relationship between FDI and other explanatory variables, such as trade openness, tax income, wages, the exchange rate, the GDP growth rate and the trade balance is highly sensitive to atomic changes in these variables. That is, a small change in these variables is believably to deter or increase FDI inflows with a large magnitude. Campos and Kinoshita (2003) use two trade related variables to examine the termination to which trade openness influences FDI inf lows for 25 countries in transition between 1990 and1998. The authors utilise an external liberalization index and trade dependence as proxies for trade openness. They argue that, the greater degree of trade openness does not only increase international trade, but also increases FDI inflows. Chang et al. (2009) also study the importance of trade openness in the economic growth of a country. They use a sample of 82 countries from all over the world for the distributor point 1960-2000. They conclude that trade openness, used in conjunction with complementary trade policies, enhances economic growth through increased FDI inflows into a country. Their finding further bolsters the position of trade openness as an important determinant of FDI. subject and Ahmed (1979) seek to analyse the determinants of manufacturing FDI in 58 developing countries for the period 1966-1970. They fork these determinants under three categories economic, social and political. Among the four important econ omic variables they study, infrastructure, per capita GDP and GDP growth rate appear to be important foreshadowor variables while the absolute of size of GDP does not help to predict FDI. They also put forward that foreign investors view long-term political stability and the extent of urbanization as important factors when choosing the location for their investments. Nunnenkamp (2002) adopts Spearman correlations to study the relationship between FDI and its determinants for 28 developing countries between 1987 and 2000. His findings show that variables such as GDP growth rate, entry restrictions, post-entry restrictions, market size, infrastructure and quality of the labour force, as measured by the years of schooling, have no effect on FDI inflows. However, he also reports positive effects on FDI of non-traditional factors such as factor cost. That is, the cheaper costs of factors of production, like lower costs of raw materials and lower costs of labour, are essential for attra cting efficiency-seeking FDI. Tsai (1991) presents an opposing view by arguing that in Taiwan FDI inflows have increased with increasing labour costs. His findings suggest that in Taiwan, there are far more important determinants of FDI than cheaper costs of factors. Indeed Tsai (1991) observes that for the years 1965-1985, Taiwans economic performance was spectacular, with an expanding domestic market and purchasing power of the economy as measured by rising GDP per capita. Singh and Jun (1995) look into three determinants of FDI in developing countries. They fabricate particular attention to socio-political stability, favourable business operating conditions and export orientation. They engage other macroeconomic variables as control factors. The authors use a political risk index (PRI) developed by Business Environment encounter Intelligence, S.A (BERI, 2009), as a measure of socio-political instability. When used in conjunction with traditional determinants of FDI such as GD P growth rate and per capita GDP, PRI appears to be highly associated with FDI for 31 developing countries for the period 1970-1993. Schneider and Frey (1995) also find political instability to be a significant deterrent of FDI for 54 less developed countries, considered over three different years 1976, 1979 and 1980. Furthermore, Singh and Jun (1995) employ an operation risk index (ORI) also developed by BERI, S.A, and taxes on international trade and transactions (ITAX). They further find that ORI is highly associated with FDI flows and has a positive sign. ITAX is also reported as an important determinant of FDI. They also find export orientation to be highly related to FDI flows, especially manufacturing exports. Asiedus (2002) investigation on the determinants of FDI in 71 developing countries provides further evidence of the importance of these extensively studied FDI determinants. Asiedu goes a little further to assess whether the same determinants of FDI have a similar impa ct on FDI flowing towards Sub-Saharan Africa (SSA) between 1980 and 1998. After a detailed analysis, she concludes that factors influencing FDI in other developing countries do not necessarily have a similar impact on FDI flows to SSA. She notes that infrastructure development and a high return on capital influence FDI flows towards developing countries in other continents, but the same factors have no influence on FDI flows towards SSA. Bende-Nabende (2002) also undertakes a study probe into the determinants of FDI flows towards 19 SSA countries for the period 1970-2000. In this study, market growth, trade liberalization and export orientation turn out to be important factors explaining why countries are able to attract foreign investors. Obwona (2001) argues that the Ugandan market size has been one of the driving forces behind FDI flows into the Ugandan economy between 1975 and 1991. Yasin (2005) uses panel data from a sample of 11 SSA countries for the period 1990-2003. His fin dings lead to the conclusion that official development assistance (ODA), trade openness, growth of the labour force and the exchange rate are important determinants of FDI, while his findings do not suggest that the growth rate of per capita GDP, a political repression index and a manifold risk index have explanatory power. Ahmed et al. (2005) examine the composition of capital flows between 1975 and 2002, to assess if South Africa is different from 81 other emergent markets. They classify relevant factors into macroeconomic performance, investment environment, infrastructure and resources, quality of institutions, financial development and global factors. The authors argue that some factors influencing capital flows are exceptional to particular forms of capital, while other factors have comparable effects on FDI, bond and equity flows. They further assert that the more open the economy is to international trade, the richer it is in natural resources, and the fewer barriers to profit repatriation it has, the more likely it is to attract FDI on a large scale. The implication of this study is that South Africa should ease its capital controls in order to avoid deterring FDI. South Africa is currently allowing repatriation of profits only within six months (Ahmed et al., 2005). The agglomeration effect is another important factor that can be used to explain why countries that have attracted FDI in the past still receive a large share of it. Notable magnitudes of existing FDI stocks in recipient countries tend to attract more FDI inflows (Lim, 2001). Foreign investors incorporate the size of the existing FDI stocks in their decisions as they seek locations where to expand their operations. Campos and Kinoshita (2003) also confirm that for 25 countries in transition between 1990 and1998, foreign investors tend to locate where others are investing, as the decision by other firms implies a favourable atmosphere for investment offered by counties in which they l ocate. Asiedu (2003), Loree and Guisinger (1995) and Lee (2005) consider effective government policies, especially the monetary and fiscal policies, as important factors that can be used to effectively attract or deter FDI inflows. Loree and Guisinger (1995) use effective tax rates for 48 countries (classified into developed and developing countries) in 1977 and 1982. After finding the effective tax policy variable to be significant, they conclude that government policies are important and that policy reforms are likely to attract more FDI. Lee (2005) investigates some evidence on the effectiveness of policy barriers to FDI for 153 developing and developed countries between 1995 and 2001. He finds strong support for the proposition that restrictive public policies deter FDI inflows. Asiedu (2003) studies the effects of investment policy on FDI for 22 SSA countries over the period 1984-2000. Her findings show that governments can increase FDI flows by developing and implementing pol icies that provide investor hail-fellow-well-met environment.sCHAPTER 3 SOUTH AFRICAS MACROECONOMIC OVERVIEW, FDI REGULATORY FRAMEWORK AND INCENTIVES.INTRODUCTIONThe direct of this chapter is to provide an overview of the South African macroeconomic performance over the period of study (1980-2003). This has been based on two regimes the apartheid regime and the democratic regime. other(a) sections of the chapter are dedicated to the regulatory framework for FDI and the incentives offered to foreign investors by the South African government.3.2 THE APARTHEID SOUTH AFRICAAccording to Lester et al.(2000), the pre-1994 period was one during which South Africa was politically unstable as a result of the racial discrimination ism (apartheid) that was adopted by the disciplineist government then in power. This created internal resistance by black South Africans, who protested against the racial discrimination practices. In 1960, the Nationalist government banned organizations such as the African National Congress (ANC) that represented black South Africans and this intensified demonstrations against the government. In receipt to the protests, the Nationalist government using armed forces, killed and arrested many black South Africans activists. These incidents drew attention from the international community, who condemned the repression against black South Africans by a Nationalist government that predominantly looked after the recreates of white South Africans. These events also caused distress among foreign investors, who became sceptical of the prospects of South Africas economic stability and the security measures of their investments. This led to capital outflow, a mounting pressure on the South African rand in foreign exchange markets, effective economic sanctions and the closing off of South Africa from the rest of the world. Despite being blessed with an abundance of natural resources, especially gold, diamonds, platinum and other minerals, South Afr ica was not a favoured location for investment during this period. Political instability, investment insecurity and violation of human rights disadvantageously inhibited FDI. Realizing the challenges that came with economic isolation, the Nationalist government, in an attempt to uphold domestic capital growth, introduced incentives for import substitution industries such as car manufacturers and military equipment (Lester et al., 2000, p.187). Despite these attempts, this period saw South Africa undergoing falling investment, diminishing international reserves, sinking economic growth, soaring rates of inflation and lofty interest rates (Nowak, 2005). During this period, the economic performance was notably disappointing as investors left(a) South Africa in search of other locations that offered better conditions for their investments. As shown in Table 3.1, the GDP growth rate was declining in some years with an average yearbook growth estimated at 1.44% per annum for the years 1980-1990. In addition, inflation and interest rates were continuously increasing with no signs of stabilising. All these were signals of difference of effective control of macroeconomic policies.Table 3.1 GDP growth, inflation and interest rates in South Africa for the period 1980-1990Year19801981198219831984198519861987198819891990GDP annual % change5.4-0.4-1.95