Foreign Direct Investment in Africa and its Determinants · Foreign direct investment (FDI) viewed...
Transcript of Foreign Direct Investment in Africa and its Determinants · Foreign direct investment (FDI) viewed...
Effects of Remittances and
Market Size on Foreign
Direct Investment to Sub-
Sahara Africa
William A. Amponsah and
Pablo A. Garcia-Fuentes Second Annual Conference on Regional
Integration in Africa July 7-8, 2011
Outline of Presentation
Introduction
Background of the Problem
Motivation
FDI and Remittances in SSA
Literature
Research Objective
Theoretical Framework and Model
Data
Results
Conclusions and Policy Implications
Introduction
Foreign direct investment (FDI) viewed as one of the
most critical external sources of development finance.
• For stimulating economic growth and employment as
nations compete to attract transnational corporations
(TNCs) to augment own production (Kumo, 2009).
• Studies report positive relationship between FDI and
economic growth (for example Bengoa & Sanchez-Robles,
2003; Campos & Kinoshita, 2002; Hansen & Rand, 2006;
Li & Liu, 2005)
• Those studies provide the impetus for many developing
countries in adopting policies targeted at attracting FDI.
Background
Global FDI inflows projected to reach $1.2 trillion in
2010, and to rise further to $1.3-1.5 trillion in 2011,
and head towards $1.6-2 trillion in 2012 (UNCTAD).
• However, FDI fell plagued by risks and uncertainties
associated with the ongoing global economic recession.
• FDI to Africa rose to historical high of $88 billion in 2008
(UNCTAD, 2009) but fell to $59 billion in 2009 due to
global economic recession (UNCTAD, 2010).
• Of the 2008 total, West Africa attracted $27 billion,
Southern Africa received $27 billion, Central Africa got $4
billion, East Africa got $6 billion and North Africa got $24
billion.
Background
But Africa’s share of global FDI is very low (5%) and
has not grown despite economic and political reforms
and recent upsurges along with those in developing
countries.
Much of African FDI has gone toward prospecting
for petroleum and precious metals.
• Recently, attention has turned to telecommunications,
agricultural lands, etc.
By 2005, remittances entering developing countries
were $188 billion (twice the ODA).
• SSA received $7 billion, only 4% of total global
remittances (Gupta et al., 2007).
Motivation
With regional integration, growth in the size of the African
market becomes important in attracting FDI.
Market size is a good and positive predictor of FDI inflows
(Bajo-Rubio & Sosvilla-Rivero, 1994; Barrel & Pain, 1996;
Billington, 1999; Gopinath et al., 1999)
Augmenting market size is also a good strategy in attracting
FDI flows to S. Africa (Fedderke & Romm, 2006).
Also, a country’s level of output (per capita GDP) and money
available for spending are related to consumption demand
(Dornbusch & Fischer, 1994).
Remittances augment recipients’ incomes, provide working
capital and other resources, and smooth consumption (Gupta et
al. (2007).
FIGURE 1
Figure 1. Net FDI Inflows, ODA Inflows, and Total Remittances Inflows
as Percent of GDP to SSA, 1970-2008
Source: Own calculations using data from the World Development
Indicators, 2010.
Figure (1) includes SSA countries as grouped by the World Bank.
FIGURE 2
Figure 2. Net FDI Inflows, ODA Inflows, and Total Remittances
Inflows in Current U.S. Dollars to SSA, 1970-2008.
Source: Own calculations using data from the World Development
Indicators, 2010.
Figure (2) includes SSA countries as grouped by the World Bank.
Literature Review
Many studies on FDI flows to SSA are descriptive, explaining
factors appealing for TNCs in locating to the region
(Dupasquier & Osakwe, 2005; Mwilima, 2003)
Empirical studies find that political instability, institutional
and macroeconomic uncertainties, and poor regulatory
frameworks negatively and significantly impact FDI flows to
Africa (Asiedu, 2002; Lemi & Asefa, 2003; Onyeiwu &
Shrestha, 2004). Have led to reforms.
• Also, incidence of wars, high inflation, distortions from capital controls
in foreign exchange market negatively and significantly impact FDI
flows to Africa (Reinhart & Rogoff, 2002).
However, none has studied the effects of market size and
remittances on attracting FDI to SSA.
Research Objective
Empirically study the effects of market size and
remittances on net FDI inflows to Sub-Sahara African
(SSA) countries.
• The study uses a panel data set for 34 SSA countries (based
on World Bank classification) from 1980 to 2009.
• The study follows Bajo-Rubio & Sosvilla-Rivero’s (1994)
cost minimization approach to derive the TNC’s optimal
level of capital at the foreign plant.
• Has found application in other studies on FDI (Love &
Lage-Hidalgo, 2000; Marchant et al., 2002; Pain, 1993).
Model Description
The model assumes the TNC decides whether or not to
undertake FDI based on output level in the country.
Total costs for the TNC defined by cost of production at home
and foreign plants.
TNC’s cost minimization s.t. total output demand => derive
equilm output production in foreign plant related to total
demand and relative unit costs.
TNC then decides on levels of inputs for producing in foreign
country => determines necessary capital stock.
Estimate demand for remittances on consumption, investment
and imports => based on disposable income (Glytsos, 2005).
Model Description
Prior studies show that TNCs consider foreign exchange rates
in location decisions (Aliber).
Trade (imports) as substitute for FDI (Mundell, 1957).
Macroeconomic stability using inflation as proxy (Romer,
2006; Barro & Sala-i-Martin, 2004; Bruno & Easterly, 1998).
Empirical model:
• FDI a function of (lnGDPP. lnREM, lnGDPP*lnREM, lnER, IM,
lnINF, lnK, ln relwages)
MODEL
MODEL continued
Equation (19): net FDI inflows depend on the factors
that determine desired capital stock (equation (17)) and
the lagged value of capital stock at the foreign plant.
MODEL continued
Variables Definition & Sources Variable name Variable definitions Source
Net FDI inflows Net FDI inflows as a share
of total GDP.
World Development
Indicators (WDI), online
version, World Bank 2010.
Per capita GDP Host country real per
capita GDP.
WDI, online version,
World Bank 2010.
Remittances/GDP Workers’ remittances,
compensation of
employees and migrants’
transfers as a share of GDP.
WDI, online version,
World Bank 2010.
Remittances/GDP* per
capita GDP
Interaction of the log of
Remittances/GDP and the
log of host country per
capita GDP.
Own calculations.
Variables Definition & Sources Real exchange rate Real exchange rate.
Dollars per unit of
foreign currency. It is
defined as in Waldkirch
(2003). It is computed by
multiplying the nominal
exchange rate by the
ratio of the host country
CPI to the U.S. CPI.
Own calculations.
First lag of imports/GDP First lag of host country
imports as share of GDP.
WDI, online version,
World Bank 2010.
Inflation Natural log of 1 plus the
annual percentage
change of GDP deflator.
GDP from WDI, online
version, World Bank
2010.
Variables Definition & Sources Lag foreign capital stock/GDP
First lag of host country foreign capital stock.
Key Data from WIR (World Investment Report) Annex Tables, UNCTAD (United Nations Conference on Trade and Development), www.unctad.org/fdistatistics.
U.S. CPI U.S. consumer price index.
International Financial Statistics CD-ROM, IMF 2010.
GDP deflator GDP deflator WID, online version, World Bank 2010.
Host country CPI Host country consumer price index
International Financial Statistics CD-ROM, IMF 2010.
SUMMARY STATISTICS
Variable Obs. mean S.D. min max
FDI/GDP 1114 0.02 0.04 -0.26 0.46
Ln per capita GDP 1142 7.89 2.19 5.21 16.56
Ln Remittances/GDP 937 -5.01 2.00 -12.35 -1.53
Ln real exchange rate 738 -4.44 2.27 -8.81 3.64
Ln of first lag host
country imports
1099 -1.04 0.48 -3.51 0.32
Inflation 1110 0.12 0.17 -0.34 1.57
Ln first lag foreign
capital stock
940 -15.93 1.34 -21.97 -13.45
RESULTS Table 1. Remittances, Per Capita GDP and Net FDI Inflows as a Share
of GDP to Sub- Sahara Africa, Panel GMM Estimation, 1980-2009
Explanatory variables Model
Constant 0.1498***
(5.16)
Log per capita GDP 0.0052*
(1.79)
Log remittances/GDP -0.0156***
(2.95)
(Log remittances/GDP)*(Log per capita GDP) 0.0010**
(2.26)
Log real exchange rate 0.0064*
(1.84)
First lag of imports/GDP 0.0165***
(2.97)
RESULTS continued
Significance: 10 percent (*), 5 percent (**) and 1 percent (***). Values
in parenthesis are t-values. The J-statistic suggests failure to reject the
null hypothesis so the instruments are valid.
Log inflation 0.0167
(1.18)
Log first lag of foreign capital stock/GDP 0.0118***
(4.78)
Year 0.0012***
(7.72)
R-squared 0.4243
Observations 684
Countries 34
J-statistic 6.223
P-value for J-statistic 0.1831
Important Results
Positive and significant effect of per capita GDP on net FDI
inflows.
• Consistent with the market size hypothesis (Garcia-Fuentes, 2009; Lall
et al., 2003; Love & Lage-Hidalgo, 2000; Tuman & Emmert, 2004).
• Transnational corporations (TNCs) are attracted to larger markets to
exploit economies of scale.
There is a complementary effect between per capita GDP and
remittance to GDP on net FDI inflows to SSA (based on the
interaction term between remittances to GDP and per capita
GDP).
• Suggests that remittances strengthen the impact of market size in
attracting FDI to SSA.
Important Results
Positive and significant effect of real exchange rate on FDI
• Consistent with results of Stevens (1998) and Waldkirch (2003).
Host country imports have a positive and significant effect on
FDI inflows => trade as complement (Mundell, 1957)
• Such complementary relationship between host country imports and
FDI also occur in Billington (1999) and Globerman & Shapiro (1999).
Lagged foreign capital stock has a significant and positive
effect on FDI inflows
• Bajo-Rubio & Sosvilla-Rivero (1994) find relationship between
previous year’s capital stock and FDI inflows can be positive or
negative.
Conclusions and Policy
Implications The key results are that (i) market size helps to attract FDI;
and (ii) remittances complement per capita income in
attracting FDI
The results are consistent with the model on economic
geography in locating economic activities in proximity to large
markets where consumption would likely take place
(Krugman, 1991).
As Africa integrates, it stands to offer a much larger market
and scale economies to attract global FDI and portfolio
investment for enhanced development.
Increase in remittances by SSA immigrants abroad
complement market size in attracting FDI.
Policy Implications
In seeking to compete for increased investment SSA
region faces three key challenges to make region
attractive under regional integration:
• Strike the right policy balance, including shared
responsibility by nations in policy harmonization and
implementing protocols.
• Enhance critical interfaces between investment and
development (eg. FDI and poverty reduction of MDGs).
• Ensure coherence between national/regional and
international investment policies, and between investment
policies and other public policies.
Policy Implications
Trade substitution found to be important in locating FDI.
• Trade liberalization challenges under Doha Development Agenda
(DDA)
• Improving market access for SSA products (AGOA, EU Economic
Partnership Agreements , reduction of trade barriers under DDA) => all
with development implications.
Investment promotion and potential assistance from OECD
countries vs effects of global financial crisis.
• Calls for sustained efforts in coordinating and harmonizing regional
macroeconomic (fiscal and monetary) policies, reducing risks of policy
reversals, good governance, etc.
Technical assistance in capacity building, infrastructure
development, health, education, etc.