U.S.

Foreign Direct Investment in Africa and its Determinants

Emmanuel Nnadozie Una Okonkwo Osili UNECA Workshop of Financial Systems and Mobilization in Africa November 2nd 2004

Outline

Motivation Central Questions Theoretical Framework Data Results Conclusions

Motivation

Foreign direct investment (FDI) represents an important source of finance for developing countries. Africas share of global FDI and US total private investment to developing countries remains low and has not grown rapidly despite economic and political reforms.

Background

FDI in Africa is relatively low, volatile, and highly concentrated in a few countries. For example, US FDI in Sub-Saharan Africa mainly in the manufacturing sector in South Africa, and the petroleum industry in Nigeria and Angola.

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

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

FDI and Remittances: A comparison

In 2002, foreign direct investment remained the most important source of external financing for developing countries, with net FDI reaching $143bn in 2002. Workers' remittances currently the second largest source of inflows $80bn last year, up from $60bn in 1998, while net lending by official creditors to developing nations was $16bn, with another $33bn given in grants.

Country Examples

A few examples from Sub-Saharan Africa: DATA from IMFs, International Financial Statistics yearbook various years SUDAN Workers' remittances averaged 417 million dollars in 1995-98,representing over 70% of export earnings and three and a half times the amount of foreign direct investment (FDI). NIGERIA Workers' remittances received on average in 1995-98 were over 1.3 billion dollars, 10% of the value of exports and roughly equal to the total of FDI. MALI At 103 million dollars, workers' remittances on average in 1994-97 were equivalent to 23.3% of export value and were greater than FDI.

Central Questions

What are the economic and political variables that influence FDI flows to Africa? How do US FDI flows differ from total FDI flows to Africa?

Theoretical Framework

US FDI = f (GDP, economic growth rate, openness, infrastructure quality, inflation, political risk, labor force quality) US FDI = + 1GDP + 2economic growth + 3OPEN + 4TELEPHONES + 5CPICHANGE + 6POLITICALRISK + 7ENROLLEMENTS +

Data

World Bank African Economic Indicators US Commerce Department -US Direct Investment Database PRS Group, International Country Risk Guide Penn World Tables

Figure 1. Total Annual US Direct Investment in Africa 1982-2001, in millions of Current US Dollars
60000

50000

40000

30000

20000

10000

0 1982 1985 1990 1995 2000

Key Definitions

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

Econometric Issues

Omitted Variable bias (some investor and host country policies may be unobserved in our analysis) Measurement error Multicollinearity (GDP growth may affect infrastructure, political risk, labor quality, and other explanatory variables).

Economic Variables

Real per capita GDP---market size Real GDP growth Openness to International Trade ratio of sum of exports to imports Inflation (Change in CPI) Labor Force Quality (literacy rate, primary school enrollments) Infrastructure quality-number of telephone lines per capita

Measuring Political Risk

Political Risk Indicator: International Country Risk Guide Rating Political instability has been shown to have a negative effect on foreign direct investment in cross-country regressions (Schneider and Frey, 1985). Since 1960, more than 40 percent of African countries have experienced at least one civil war (Collier and Hoeffler, 2002). --- may pose substantial barriers to FDI inflows to the region.

Summary Statistics
Variables Log GDP per Capita Real GDP Growth Openness Infrastructure (Log telephones per capita) Inflation Rate Political Risk Index Literacy Primary School Enrollments N 33 33 34 36 33 35 31 34 Mean 6.241 0.241 0.636 1.956 201.267 53.141 56.921 85.523 Median 6.049 0.483 0.576 1.573 10.589 54.6 58.9 93.152 Standard Deviation 1.013 2.521 0.264 1.292 911.834 12.309 18.579 32.293 Minimum 4.633 -7.712 0.261 -0.315 3.376 25.25 13.225 28.733 Maximum 8.406 4.944 1.357 4.596 5210.914 77.714 84.4 162.58

Political Risk

Political Risk may pose barriers for US FDI in Africa? Interesting context: High concentration of FDI flows in the primary resource extraction sector may lead to an unclear relationship between

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

Main Findings

Total FDI appears more responsive to economic and political variables than US FDI. Political Risk has a a significant, negative impact on total FDI and FDI as a share of GDP, less clear for US FDI GDP growth rate, literacy, and Openness have a positive and significant impact on total FDI

Other Findings

Less robust evidence on the role of GDP per capita and infrastructure Inflation rate has a negative effect on FDI inflows, but less robust

Conclusions

There is still a considerable proportion of the variation in total FDI and US FDI not explained by the model. Other potential explanations: bias toward Africa or by a lack of information and knowledge about African business opportunities?

Future Work

Need to study the effect of changes in wages, monetary and exchange rate policy, taxation and other variables that may influence FDI flows for several African countries. Institutions, government policies, geography, ethnic diversity, and other factors that may be difficult to capture within a regression framework.

POLICY IMPLICATIONS

A number of countries have undertaken economic and political reforms in Africa, but has not led to a significant expansion in US FDI to the region. In a competitive global economy, it is not enough just to improve one's policy environment: improvements need to be made both in absolute and relative terms (Asiedu, 2004).