The Political Economy Of Foreign Direct Investment In … · · 2010-07-29The Political Economy...

The Political Economy of Foreign Direct Investment in Malawi – MLB Thesis

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The Political Economy Of

Foreign Direct Investment In

Malawi

COLLINS MAGALASI

Date: 17 July 2009

This is a Bucerius/WHU MLB thesis

14,639 words (excluding footnotes)

Supervisor 1: Prof. Dr. Michael Frenkel

Supervisor 2: Dr. Patrick Kambewa


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Table of Contents

Table of Contents ........................................................................................................2

Table of Figures...........................................................................................................3

Table of Tables ............................................................................................................3

Table of Annexes ........................................................................................................3

List of Abbreviations ...................................................................................................4

Chapter One: Introduction...................................................................................6

Chapter Two: Determinants of Foreign Direct Investment ............................8

I. Locational/Host Country Determinants .............................................................9 II. Factors that affect location of Foreign Direct Investment ...............................11

Chapter Three: Theories of Foreign Direct Investment...................................14

I. Root Theories...................................................................................................15 1. Theory of Industrial organisation.................................................................15 2. Theory of International trade .......................................................................16

II. Theories explaining the activities of FDI.........................................................17 1 Internalisation theory of FDI .......................................................................18 2. Eclectic paradigm theory of FDI..................................................................19 3. Macro Theory of FDI...................................................................................19 4. Factor Endowment Theory and New Trade Theory ....................................20

Chapter Four: Previous Empirical Findings ..........................................................21

I. Macroeconomic environment instability .........................................................21 1. Studies that support theory that macroeconomic instability deters FDI ......23 2. Studies that reject theory that macroeconomic instability deters FDI .........25 3. Studies that mend the missing link ..............................................................26

II. Legal environment uncertainty ........................................................................26

Chapter Five: Foreign Direct Investment Environment in Malawi ..............31

I. The Malawi Political Economy .......................................................................31 II. The Macroeconomic Environment ..................................................................35 III. The Legal Environment ...................................................................................42

1. Amendment of investment related laws in Malawi .....................................43 2. Presidential and Ministerial Decrees ...........................................................50 3. Legal Environment Uncertainty Index for Malawi......................................53

IV. The Flow of Foreign Direct Investment in Malawi .........................................57

Chapter Six: Testing The Hypothesis ...............................................................62

I. Methodology ....................................................................................................62 II. Results..............................................................................................................63

Chapter Seven: Conclusion..................................................................................65


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Bibliography ...............................................................................................................66

Annex ..........................................................................................................................75

Table of Figures

Figure 1a: Host Country Determinants of FDI…………………………….....10

Figure 1: Real Growth rates, Inflation Rates and Lending Interest Rates

……………………………………………………………………………………….39

Figure 2: Real Effective Exchange Rates ………………………………….41

Figure 3: Most Amended business-related laws ………………………….45

Figure 6: Presidential and Ministerial Decrees in Malawi ………………..52

Figure 7 Investment related law amendments and decrees …………….53

Figure 8: Legal Uncertainty Index for Malawi ……………………………...54

Figure 9: Year-to-Year Contribution to the legal Environment Uncertainty

……………………………………………………………………………………….56

Figure 10: FDI inflows to Malawi ……………………………………………..61

Table of Tables

Table 1: Sectoral percentage contribution to GDP ………………………36

Table 2: Investment Related Laws amended …………………………….43

Table 3: Top-3 Most amended laws ……………………………………….46

Table 4: Priority Laws by Investors and stakeholders …………………...48

Table 5: Aggregate decrees on imports and exports …………………….52

Table 6: Malawi FDI flows …………………………………………………..60

Table 7: Results of Model A ………………………………………………..63

Table 8: Results of Model B ………………………………………………..64

Table of Annexes

Annex 1: Results of Regression Analysis ………………………………….75

Annex 2: Questionnaire ……………………………………………………...77

Annex 3: Amendments to Laws of Malawi …………………………………83


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List of Abbreviations

ACP Africa Caribbean and Pacific

AfDB African Development Bank

AU African Union

COMESA Common Market for Eastern and Southern Africa

DPP Democratic Progressive Party

ECAMA Economics Association of Malawi

EPZ Export Processing Zone

ESAF Enhanced Structural Adjustment Facility

FAO Food and Agriculture Organisation

FDI Foreign Direct Investment

FTA Free Trade Area

G-77 Group of 77

GDP Gross Domestic Product

HIPC Highly Indebted Poor Country

IBAM Indigenous Business Association of Malawi

ICSID International Convention for Settlement of Investment Disputes

ILO International Labour Organisation

IMF International Monetary Fund

LEUI Legal Environment Uncertainty Index

MCCCI Malawi Confederation of Chambers of Commerce and Industry

MCP Malawi Congress Party

MDG Millennium Development Goal

MDRI Multilateral Debt Relief Initiative

MEGS Malawi Economic Growth Strategy

MGDS Malawi Growth and Development Strategy

MIGA Multilateral Investment Guarantee Agency

MIPA Malawi Investment Promotion Agency

MPRSP Malawi Poverty Reduction Strategy Paper

NSO National Statistics Office

OLI Ownership, Location and Internalisation

PRGF Poverty Reduction and Growth Facility

RBM Reserve Bank of Malawi


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REER Real Effective Exchange Rate

RIA Regional Investment Agency

SADC Southern Africa Development Community

UDF United Democratic Front

UN United Nations

UNCTAD United Nations Conference on Trade and Development

UNIDO United Nations Industrial Development Organisation

USSR Union of Soviet Socialist Republics

WDR World Development Report

WTO World Trade Organisation


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Chapter One: Introduction Empirical evidence shows that one percentage point increase in FDI

measured as a proportion of GDP, brings about ceteris paribus an extra 0.8

percentage point increase in per capita income.1 UNCTAD (2002) states that

of all developing countries and economies in transition, the fastest growing

economies are those that receive most foreign direct investment.2

Previous empirical findings on the determinants of FDI flows in transition and

developing countries have shown that legal environment uncertainty and

macroeconomic instability scare off foreign direct investors. So far, there is no

recorded academic finding on the subject in Malawi, but only inference has

been made from similar studies that were conducted on other developing and

transition countries but all outside the Southern Africa region. Those other

studies however did not explore which of the variables, i.e. between

macroeconomic instability and legal environment uncertainty, has higher

impact on FDI flows. This paper investigates this question and will therefore

be one of the few contributions to the literature not only on the impact that

macroeconomic instability and legal uncertainty have on FDI in Malawi, but

also on the comparative weight between the legal and macroeconomic

determinants.

Malawi has experienced both legal environment uncertainty and

macroeconomic instability from 1994 to 2008, and yet FDI inflows were

observed to fluctuate. Anecdotal evidence shows that FDI inflow is attracted

more by macroeconomic stability than legal certainty. This paper uses

evidence from Malawi to test the hypothesis that macroeconomic instability

negatively affects FDI inflow more than legal environment uncertainty does.

This paper is organised as follows: Chapter Two introduces FDI determinants

in general and host country determinants in particular. Theories of FDI are

discussed in Chapter Three. The theories are both those that are for and

1 Bergsman et al (2000), in the World Bank Policy Working Paper 2329 2 UNCTAD, World Investment Report: Transnational Corporations and Export Competitiveness, 2002


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those against the determination that macroeconomic stability and/or legal

certainty are key determinants of FDI. This is followed by a review of previous

empirical findings on the subject, including a discussion on the conflicting

evidence that is provided by scholars on the matter in Chapter Four.

Chapter Five details the FDI environment in Malawi. The Chapter looks at the

political economy of Malawi; documents the developments that have occurred

in the Malawi economy and legal system from 1994 to 2008; and also provide

record of the FDI flows into Malawi.

With the data enumerated in the foregoing chapters, the paper runs standard

OLS multivariate regression in Chapter Six to test the hypothesis of this

paper. Thereafter the paper ends with conclusion in Chapter Seven that

indeed that macroeconomic instability negatively affects foreign direct

investment inflows more than legal environment uncertainty does in Malawi.


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Chapter Two: Determinants of Foreign Direct Investment

Foreign Direct Investment refers to an outlay whereby a firm or person from

one country develops a long-term relationship and control of at least 10% in

assets of a foreign enterprise in a country other than his own. This investment

includes the initial transaction into the new country and also subsequent

transactions between them and among foreign affiliates.

Feenstra R (1998) follows the approach to FDI developed by John Dunning

(1977) and describes FDI as having three features: First is the acquisition of

at least 10% of assets abroad (ownership), second is the choice of host

country which is dependent on the host country conditions (location); and third

is the decision on which activities the enterprise will do (internalisation). These

aforementioned features of FDI – ownership, location, and internalization - are

commonly referred to as the “OLI framework,” and although not constituting a

formal theory in itself that can be confronted with statistical processes,3 the

framework provides a useful skeleton for categorising much of the empirical

studies conducted on FDI.

The benefits of FDI have been empirically proven and documented by many

persons, among them UNCTAD (1998), Brenton P. and Mauro F. (1998)), Lu

J and Beamish P (2006), Kokko et al (2001), Obwona M (2001, and Baniak,

Cukrowski and Herczynski (2002). Of special mention is John Dunning who

provides a long list of benefits of FDI. In his 1994 paper “Re-evaluating the

benefits of foreign direct investment,” Dunning cites the following benefits of

FDI: Provision of new financial capital and complementary assets; Access to

foreign markets; Increased standards of product quality; Improvements in

international division of labour and cross border networking; Stimulation of

local entrepreneurial and domestic rivalry; and Possible stimulation of

secondary processing activities from the local spin-off effects on industrial

activities by FDI.4 The International Monetary Fund et al (1991) states that

3 See Neary P (2008) for more discussion on categorisation of FDI studies 4 Dunning (1994), pp. 7-10


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FDI is an important factor in the restructuring of enterprises and transfer of

capital and know-how particularly for countries in transition.5 In addition,

Piatkin (1993) states that FDI has potential to relieve tensions in poor

countries.6

A lot of scholarly research has proved that FDI is very instrumental to

development of poor countries and countries in transition. UNCTAD (2002)

states that of all developing countries and economies in transition, the fastest

growing economies are those that receive most FDI inflows.7 Empirical

evidence provided by Bergsman et al (2000) shows that one percentage point

increase in FDI measured as a proportion of GDP, brings about, ceteris

paribus, an extra 0.8 percentage point increase in per capita income.8 For FDI

to occur, however, three important factors must exist simultaneously, namely

the firm must be convinced “why” it should invest (ownership advantage),

“where” (locational advantage) and “how” (internationalisation advantage).9

This paper is interested in locational determinants.

I. Locational/Host Country Determinants

Specific to the locational advantage, which this study is interested in, many

empirical studies of FDI determinants, including UNCTAD (1998), show that

location of FDI depends on (a) the motivation of the FDI (whether it is natural

resource-seeking, market seeking, efficiency seeking or strategic asset

seeking),10 (b) the economic and business environment of the host country

(particularly the policies and practice pursued by the government), and (c) the

mode of entry or expansion by the firm - whether as Greenfield FDI or through

Merger and Acquisition.

5 IMF et al, A Study of the Soviet economy, 1991 6 Piatkin A., pp. 61-73 7 UNCTAD, World Investment Report: Transnational Corporations and Export Competitiveness, 2002 8 Bergsman et al (2000), in the World Bank Policy Working Paper 2329 9 This description forms the OLI Framework that Dunning (1993a) used in the Eclectic theory of investment 10 For detailed description, see Anand J and Delios A (2001)


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Of the three determinants aforementioned, only the economic and business

environment of host country is directly within the control of host governments.

Host governments therefore organise specific policy frameworks and

practices that are aimed at attracting and retaining as much of FDI as possible

in order to maximise the benefits that come with FDI. Figure 1a below is

adapted from UNCTAD (1998)11 and it summarises the factors that determine

FDI in host country.

Source: UNCTAD (1998, p.91, Table IV.1

In this paper, we will do an empirical analysis of the policy framework of

Malawi specifically the impact that the macroeconomic instability and the legal

uncertainty have on FDI in Malawi. So far, there is no recorded academic

discussion on the subject in Malawi. Inference can be made, however, from

11 UNCTAD (1998) p. 91, Table IV.1

I. Policy framework for FDI • economic, political and social

stability • rules regarding entry and operations • standards of treatment of foreign

affiliates • policies on functioning and structure

of markets (especially competition and M&A policies)

• international agreements on FDI • privatization policy • trade policy (tariffs and NTBs) and

coherence of FDI and trade policies • tax policy

II. Economic determinants

III. Business facilitation • investment promotion (including

image building and investment-generating activities and investment-facilitation services)

• investment incentives • hassle costs (related to corruption,

administrative efficiency, etc.) • social amenities (bilingual schools,

quality of life, etc.) • after-investment services

Host country determinants Type of FDI classified Principal economic determinants by motives of TNCs in host countries

• market size and per capita income • market growth • access to regional and global

markets • country-specific consumer

preferences

• structure of markets

A. Market-seeking

C. Efficiency-

seeking

B. Resource/

asset-seeking

• cost of resources and assets listed under B, adjusted for productivity for labour resources

• other input costs, e.g. transport and communication costs to/from and within host economy and costs of other intermediate products

• membership of a regional integration agreement conducive to the establishment of regional corporate networks

• raw materials • low-cost unskilled labour • skilled labour • technological, innovatory and

other • created assets (e.g. brand

names), • including as embodied in • individuals, firms and clusters • physical infrastructure (ports, roads,

power, telecommunication)

Figure 1a: Host country determinants of FDI


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similar studies that were conducted on other developing and transition

countries, unfortunately none of which is from within the Southern Africa.12

Baniak at al (2002), in their study of transition economies in Central and

Eastern Europe looked at the link between macroeconomic and institutional

stability and FDI inflows. They suggest that in order to attract a significant

inflow of long-term and non-speculative foreign capital, transition countries

need a stable institutional environment. They did not indicate, however, which

of the variables in the institutional environment has higher impact on FDI

flows. This paper will therefore be one of the few contributions to the literature

not only on the impact that macroeconomic instability and legal uncertainty

have on FDI in Malawi, but also on the comparative weight between the legal

and macroeconomic determinants.

II. Factors that affect location of Foreign Direct

Investment

In the above section we looked at determinants of FDI, in particular the host

country determinants. We have seen that governments strive to provide an

environment that is desirable and conducive for FDI. But are these desirable

determinants static?

Dunning (2003) states that locational variables that affect FDI are fast

changing. He proved this by studying the interests of investors in the period

1970 – 1980 and 1990 – 2000.13 This finding is corroborated by the

Economist Intelligence Unit (2002) and (2004) surveys of business

executives’ rankings of where they can locate their FDI in the early 21st

century. The 2002 survey revealed that businesses look at the following as

key variables in choosing the location of their firms: Political stability, Quality

of institutional infrastructure, macroeconomic environment of the host country,

government policies towards private sector and competition, as well as

Quality of social capital.14 In 2004, the Economist’s survey had the following

12 UNCTAD (2008) and Sung and Lapan (2000) express that such information is not forthcoming from the Southern Africa sub-region. 13 Dunning (2003) in Annual World Bank Conference on Development Economics, pp. 279 - 290 14 The Economist Intelligence Unit, World Investment Prospects 2002


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variables in their order of importance: Local market opportunities,

Macroeconomic stability, Political environment (political stability and

effectiveness), Overall policy towards free enterprise and competition,

Specific policies towards foreign investment, An open foreign trade and

exchange regime, Overall taxation regime, Labour market and skills,

Availability of special tax incentives, Quality of infrastructure, Geographical

location, Quality of local suppliers, and Quality and availability of local

financing.15

In addition, Dunning and Wymbs (2001) state that there are additional factors

that affect the location of FDI. These include the impact of internet, particularly

electronic commerce, on location decisions of firms. They state that internet,

being a market-facilitating instrument, lessens the motivation of firms to locate

their activities all over the world as it reduces information asymmetries in

firms, thus reducing spatial transaction costs.16 However, Dunning and

Wymbs (2001) fail to realise that internet does not provide solutions to all

activities on the market as there exist a lot of market failures or distortions that

need idiosyncratic presence of the firm.

Krugman (1992) and Krugman and Venables (1994) point out that there is

growing agglomeration of related activities by firms, in the process locating

firms in counties that are not on the traditional list of destinations of firms.

They give examples of agglomeration of high-technology activities in the

Silicon Valley, Financial services sector in London and Hong Kong, Software

activities in Bangalore India, and Cutlery industry in Solingen Germany. Thus,

they conclude that as firms make decision on what activities to engage in,

they would choose a location that allows them to maximise competitive

advantage.

15 The Economist Intelligence Unit, World Investment Prospects 2004, p 22 16 Dunning (2001) in Annual World Bank Conference On Development Economics – Europe 2003, p. 286


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In view of the foregoing, it is imperative that governments of potential host

countries keep upgrading their surveillance of the investment determinants of

the firms. The approach of business-as-usual will not attract and retain FDIs.


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Chapter Three: Theories of Foreign Direct Investment

After examining the factors that affect the location of FDI, the paper next

presents the prevailing theories of FDI. The theories here-mentioned are

instrumental in explaining the behaviour of FDI, and specifically for this paper,

in the empirical testing of the paper’s hypothesis that macroeconomic

instability negatively affects foreign direct investment more than legal

environment instability does in Malawi.

Literature provides many theories that can explain foreign direct investment.

Rugman (1980) however quickly dismisses the point and states that “the

existing theories are basically sub-sets of the general theory of

internationalisation.”17 He believes that there is only one theory of FDIs,

namely internationalisation, originated by Coase (1937), and that Hymer

(1976) only applied it to an international setting as compared to Coase who

applied the theory to local setting. Rugman (1980) further argues that Buckley

and Casson (1976) and also Dunning (1977) only blended the same theory.18

Buckley (1988) seems to agree with Rugman (1980) when he outlines the

difficulties of empirically testing the validity of the related theories separately,

particularly theories that ponder on internalisation decisions, market structure

and competitive advantage.19 He suggests as a solution the ‘integration of

non-traditional concepts’ and ‘the reintegration of areas of research that have

become divorced from international business theory’20

While it may not be possible to identify totally independent theories of FDI, it is

possible to identify the roots of international production. This will offer a

framework with which to understand FDI and conduct empirical analysis of

determinants of FDI. This paper therefore first looks at the Theory of Industrial

17 Rugman A., (1980) p. 24 18 Ibid, p.24 19 Buckley P., Problems and Developments in the Core Theory of International Business, (1990), p. 657 20 Ibid, p 665


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Organisation and the Theory of International Trade. Thereafter the paper will

look at hybrid theories that explain the activities of FDIs.

I. Root Theories

1. Theory of Industrial organisation

The theory of Industrial Organisation was propounded by Hymer (1960)21 and

can be said to be the mother of all theories of foreign direct investment.

Before the pioneering work by Hymer, international capital flow was viewed

from a neoclassical financial theory of portfolio flows, where it was assumed

that capital moved in a frictionless world and that it moved in response to

changes in profits or interest rates differentials.22 Indeed Dunning (1958)

collaborated with Iversen (1936) that the early work on FDI was focussed on

the destination on the capital and not the reasons for the movement.23 Hymer

changed the aforementioned discussion by bringing in two major determinants

of FDI namely removal of competition and intrinsic advantages firms posses in

a particular activity.24 Therefore, Hymer’s theory transformed the limited views

that prevailed at that time that FDIs were institutions for international

exchange. In the theory, Hymer distinguished portfolio from direct investment

and focused on control by investors and development over time.

Dunning J. and Rugman A. (1985) praised Hymer for influencing scholars

through the theory of industrial organisation to move towards the use of

industrial organisation theory in the analysis of multinational enterprises, away

from the “intellectual straight jacket of neoclassical-type trade and financial

theory.”25

21 This was in his doctoral dissertation, which was delayed to 1976 22 Iversen C (1936) 23 Dunning (1958), for example, was interested in explaining the presence of American FDIs in Britain and not the factors that led to the inflow or the nature of its operations. 24 Hymer (1960/1976) p.331. 25 Dunning J. And Rugman A., The Influence of Hymer’s Dissertation on the Theory of Foreign Direct Investment, in The American Economic Review, Vol 75, No. 2 1985 pp. 228


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Thus, as detailed by Hymer (1960), FDIs are institutions for international

production. The assertion of the industrial organisation theory is very

important to this study of foreign direct investment in Malawi, a country that

opened up its economy just in the early 90s.

2. Theory of International trade

This theory is built on the product life cycle theory by Vernon (1966). Studying

the firms from the U.S. in the 1960s, Vernon concluded that a firm will go

through a number of stages namely: In Stage 1 - the firm is located in an

innovative country, produces new product and serves the home market; In

stage 2, the firm matures, produces standardized designs and products,

resultantly offer lower price, and other industrialized countries join production;

At stage 3, the firm invests in developing countries, produces at cheaper cost

and export back to home and other markets. Stage 4 sees technological

diffusion and realises full globalization.26

Although Vernon claims that the theory “puts less emphasis upon comparative

cost doctrine and more upon the timing of innovation, the effects of scale

economies and the roles of ignorance and uncertainty in influencing trade

patterns,”27 the theory has been panned for its failure to explain trade patterns

of today. This extends to the theory’s ambiguity to the applicable context; its

treatment of processes of innovation; its oversimplification of the nature of

products; and assumptions about scale, labour and relocation to developing

countries.28 The theory was developed at a time when the United States of

America was viewed as the only country of innovations, a situation that is not

the case anymore. These days, firms in different countries (beyond the United

States of America) introduce new products in many different markets at the

same time in order to take advantage of opportunities that exist in those

environments.

26 Vernon R., International Investment and International Trade in the product Cycle (1966) pp. 190-207 27 Ibid, p.190 28 Taylor M. has a detailed critique of Vernon’s Product-Cycle Model in: Environment and Planning A, (1986), pp 751 - 761


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Nevertheless the theory helps to explain some of the drivers of firms’ decision

to invest abroad and help this study in determining the applicable

determinants of FDIs. Going by Vernon’s theory, FDIs are a product of a firm’s

focus on prospects of cutting costs by locating production in countries where it

can produce at lower net cost.

II. Theories explaining the activities of FDI

There are many theories that explain the activities of FDI. In this section we

will look at only a few of them that are relevant to our study namely the

Internalisation Theory, the Eclectic Paradigm Theory, the Macro Theory,

Factor Endowment-Based Theory and the New Trade Theory. But before we

get in detail into the theories, let us look at the classification of FDI by activity

as promoted by Dunning (2003). Based on UNCTAD (1998) host country

determinants of FDI,29 Dunning classifies FDIs as Resource-seeking, Market

seeking, Efficiency-seeking, and Strategic asset–seeking FDIs.

Resource-seeking FDI acquires particular resources such as land, raw

materials, and skilled or unskilled labour, at lower real cost than they could

have acquired the same in their home countries. Market seeking FDI goes for

the market that the host country or neighbouring countries offer, as such

these types of FDI are interested in the market size, per capita income and

growth, consumer preferences and access to regional and global markets.

Efficiency-seeking FDI are resource seekers and / or market seekers who

wish to exploit economies of scale. These are interested in minimising the

cost of resources and assets and are members to processes that promote

inter-country division of labour and international competitiveness. Finally,

Strategic asset-seeking FDI acquires assets for long-term strategic objectives

such as international competitiveness. These assets are innovation-

enhancing and include technology, human and physical infrastructure.30

29 UNCTAD (1998), page 91, table IV.1 30 Dunning J, Determinants of Foreign Direct Investment (2003), pp 279-285


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Whatever classification of FDI by activity, both Dunning (1993) and Rugman

(1998) corroborate that it is imperative that the environment in which

investment will be done is stable and predictable.

1 Internalisation theory of FDI

A number of authors have supported the internalisation theory of foreign

investment as ably providing microeconomic or behavioural explanations of

foreign investors. In particular, Internalisation theory explains the emergence

of foreign investment as result of market failures (Caves (1971). McManus

(1972), Buckley and Casson (1976), Caves (1971) and Swedenborg (1979) all

state that a business will invest abroad when transaction costs associated

with trading with the outside world exceed the cost on internalisation, which

include the quest to acquire updated knowledge of the market country.

Johanson (1977) and Vahlne (1990) of the Uppsala School studied the

gradual increase in international business by various firms and concluded that

market failures give rise to ownership specific advantages that are external to

the firm. 31 Vida I, Reardon J. and Fairhurst A. (2000) of the same Uppsala

school of thought qualify the finding further by stating that this ownership

advantage-taking applies only to mature markets.32 It can therefore be

extrapolated that a firm’s country specific knowledge enables the recognition

of business opportunities and planning against insecurity.

The internalisation theory of investment has three important implications to

our study and these have been clearly established by Meyer (1998a). First,

firms follow a sequence from a low to a higher mode of involvement. Thus if

the investment environment looks promising, they will proceed to the next

step. Second, firms first enter into markets that have similar characteristics to

31 Uppsala School is a sociological orientation of philosophy that believes that theory must be provable and that “hypotheses must be of greater interest to those empiricists who make observations with the additional ambition to demonstrate general laws. They must have some leading principle which guides their observations.” Sourced at http://asj.sagepub.com/cgi/reprint/1/1/85 last visited on May 10 2009 32 Vida et al (2000), p. 37


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home country. These characteristics may be geographical, cultural, political,

language, standards etc. Third, the initial investment in a foreign country

serves as a way of testing the investment environment in form of

accumulating experience and knowledge or just to develop a brand loyalty

with customers. Here again, the quality and quantity of investments will

depend on the perception that investors have on the investment climate in the

host country.

2. Eclectic paradigm theory of FDI

Eclectic paradigm theory was provided as a composite of many theories by

Dunning (1977) to give a framework within which FDI can be explained.

Dunning says that for FDI to occur, there must be answers to “why”

(ownership advantage), “where” (locational advantage) and “how”

(internationalisation advantage). He further says two market imperfections

necessitate eclectic paradigm namely structural market failure that

discriminates between firms in their ability to access and exercise control over

property or value-added rights; and intermediate markets that fail to transact

goods and services at a lower net cost than the firm can do within.

The eclectic paradigm theory is therefore important to our study as it tells us

the conditions that need to be fulfilled for FDI to be undertaken. Investors

want ownership, locational and internalisation advantages, and as stated

above, the eclectic paradigm theory gives these microeconomic explanations.

3. Macro Theory of FDI

There exists also the Macro theory of FDI which states that firms compare

costs and benefits of producing in different locations. Tondel (2001) takes FDI

as desired capital stock in a given foreign host country that is dependent on

the profitability of the firm; Tondel further states that Macro Theory treats FDI

flow as “the difference between desired stock of capital at time t, given the

actual stock at time t-1”33 and is dependent on the general level of business

33 Tondel (2001) page 20


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environment i.e. political and economic stability, liberalisation, level of taxes,

level of technological development and level of human capital.

4. Factor Endowment Theory and New Trade Theory

There are a number of other theories that have been floated for their

relevance to developing and transition countries. Prominent however are two

important theories on the same, namely, Factor Endowments-based Trade

Theory and the New Trade Theory. Factor endowment-based theory states

that FDI goes mostly to countries with more abundant natural resources and

lower wages.34 The New Trade Theory suggests that agglomeration effects35

often play a crucial role and that economies of scale are a driving force of

FDI.36 The New Trade Theory allows us to conclude that foreign investors

may be attracted to countries with existing concentrations of other foreign

investors. Being less knowledgeable of local environments of the country,

investors may consider the investment decisions by others as a good signal of

favourable conditions and emulate the decision to reduce uncertainty.

The above mentioned theories have been developed in different times and

tested in different locations. Their applicability in poor, developing and

transition countries is however limited. For example, the popular study of FDI

determinants in transition economies by Bevan and Estrin (2000) is on 11

countries in Central and Eastern Europe;37 Tondel (2001) expands the list to

25 countries, but all in the same region;38 and Resmini (2000) studies 10 of

these countries. Exceptions are Baribaldi et al (2001) and Kinoshita et al

(2003) who cover more transition countries, albeit none of the countries is

from Southern Africa.

34 Kinoshita Y and Campos N (2003) 35 Agglomeration effects refer to instances where investors co-locate near other economic units for positive externalities. Examples are location of high-tech activities in Silicon Valley and Route 128 in the United States of America, and Software activities in Bangalore India. 36 Wheeler and Mody (1992), Head, Ries, and Swenson (1995), Kinoshita and Mody (2001), Kinoshita Y and Campos N (2003) 37 The countries are Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovenia, and Ukraine. 38 The added countries are Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Uzbekistan, Croatia, Albania, FYR Macedonia, and Slovak Republic.


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Chapter Four: Previous Empirical Findings

There is no recorded academic discussion on the implication of legal

environment uncertainty and macroeconomic instability on foreign direct

investment in Malawi. Inference can be made, however, from similar studies

that were conducted on other countries.

This section looks at previous work that has been conducted on the

relationship between macroeconomic stability, legal certainty and FDI. The

hypothesis we will be proving is derived from the theories and determinants

presented above, and also the empirical findings presented here below.

It must be pointed out that there are conflicting findings on both theory and

empirical studies. We will attempt to explain the sources of the differences in

the findings and propose where possible the line of alignment.

I. Macroeconomic environment instability

Macroeconomic stability is an important factor in the country’s attracting and

retaining investors, and attainment of sustainable economic growth and

development. Macroeconomic stability is a product of responsible fiscal

policies combined with sound monetary policy.

To study macroeconomic instability, one would be interested in a number of

variables among them interest rates, inflation and exchange rates. But to

study the behaviour of FDI, it is suggested to use international prices which in

this case is Real Effective Exchange Rate39 (REER), than would domestic

interest rates or inflation alone. Exchange Rate movement has therefore been

interpreted as suggesting the state of the macroeconomic environment.40

39 The Real Effective Exchange Rate is a weighted average of bilateral real exchange rates (RERs) between a country and each of its trading partners, weighted by the respective trade shares of each partner, and adjusted for effects of inflation. The RER between two currencies is the product of the nominal exchange rate and the ratio of prices between the two countries. 40 Zanello A. and Dominique D. (1997), IMF Working Paper, WP/97/71


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Specifically, due to the enormous negative effect that currency misalignment

(overvaluing or undervaluing) may have on country and global business

competitiveness, growth and development, global institutions such as the

International Monetary Fund (IMF) monitor movements of the Real Effective

Exchange Rate (REER). The IMF defines the Real Effective Exchange Rate

as “the weighted geometric average of the price of the domestic country

relative to the prices of its trade partners” 41 and is indicator for the state of the

economy.42 There is consensus that exchange rate movement, particularly

Real Effective Exchange Rate (REER) is a good indicator of macroeconomic

stability.43 Consequently, most studies on the effect of macroeconomic

stability as determinant of FDI centre on real effective exchange rate volatility.

There exists conflict of proof for and against the theory that macroeconomic

instability deters FDI. While some scholars such as Goldberg and Kolstad

(1995), Cushman (1985 and 1988), Rivoli and Salorio (1996), Campa (1993)

and Aizenman (1993) have confirmed the theory, others have rejected the

theory among them Mundell (1957), Goldberg and Kolstad (1995), Cushman

(1985, 1998), Negishi (1985) and Sung and Lapan (2000).

The conflict also exists on the evidence that is presented to prove the point.

Scholars such as Amuedo, et al (2001), Chakrabarti and Scholnick (2001) and

Galgau and Sekkat (2004) claim they empirically proved that exchange rate

volatility does deter FDI; while Cushman (1985 and 1989), Goldberg and

Kolstad (1995), Zhang (2003) and Galgau and Sekkat (2004) state that their

empirical analysis did not support the theory. We will now go into details of

these contradicting findings:

41 See Zanello A. and Dominique D. (1997), A Primer on the IMF's Information Notice System, IMF Working Paper, WP/97/71. 42 ibid 43 ibid


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1. Studies that support theory that macroeconomic instability

deters FDI

Goldberg and Kolstad (1995) analysed the implication of short-term exchange

rate variability with regard to FDI flows assuming that the investors are risk

averse. This assumption was shared with Cushman (1985 and also 1988).

They assumed that location decision of the firm has already been made and

that the choice before the firm is how much they should produce (i.e. there are

already production plans in both home and foreign countries). They found out

that exchange rate volatility decreases the overall production. Thus they

supported the theory as working for risk-averse investors. However the effect

of this on the absolute level of FDI is unclear.

Rivoli and Salorio (1996) and Campa (1993) looked at the impact of

macroeconomic uncertainty on FDI decision-making using the real options

approach. The authors state that in the context of exogenous uncertainty,

which affects exchange rate, firm specific advantages as enumerated on the

OLI framework have implications on investment. In their model, they

demonstrate that realising stronger ownership advantages can delay

investment decision, while stronger internalisation makes FDI less reversible.

Thus while Ownership and Internalisation create rationale for FDI, Rivoli and

Salorio (1996) argue that in times of uncertainty the best option is to "wait and

see,"

Aizenman (1993) investigated the factors that determine the impact of

exchange rate regimes on FDI and the correlation between exchange rate

volatility and investment. He found out that exchange rate volatility prevents

the use of FDI as hedging device. In his model he assumed a firm can

relocate its production and employment easily towards the more efficient or

cheaper plant in the other country. He showed that a fixed exchange rate

regime is more conducive to FDI relative to a flexible exchange rate. As for

the flexible exchange rate, Aizenman (1993) showed that the correlation

between investment and exchange rate volatility depends on the nature of the


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shocks, i.e. where the dominant shocks are nominal, there is a negative

correlation and where the dominant shocks are real, a positive correlation is

observed. 44

Amuedo-Dorantes and Pozo (2001) did empirical analysis to find out whether

the macroeconomic uncertainty experienced by investors in the pre-war

period was different from the experience in the post-war period. To do this,

the authors ran macroeconomic variables over the two historical time periods.

They confirmed the hypothesis that the nature of the macroeconomic

uncertainty differs in the pre-war and post-war periods but both affect

investments.45

Chakrabarti and Scholnick (2002) used panel data techniques to test the

theory of conditional skewness in asset pricing for FDI. The authors found that

exchange rates skewness negatively affects FDI flows.46

Drawing analogy of high levels of corruption to macroeconomic instability,

Campos at al (1999) write that corruption is the single most annoying form of

macroeconomic deterrent to FDI. They state that not only are investors

concerned with the level of corruption, but also the predictability of corruption.

Tondel (2001) agrees with Campos at al (1999) and sums up the preceding

worry by stating “if the bribe payer gets what he pays for, corruption will not be

as damaging to FDI as if the outcome of paying a bribe is uncertain”47

The preceding paragraphs support the theory that macroeconomic instability

negatively affects FDI. Next, we will look at studies that have contrary views.

44 Aizenman (1992) in International Monetary Fund Staff Papers, Vol. 39, No. 4, pp. 890-922 45

Amuedo-Dorantes and Pozo (2001), in: Journal of Macroeconomics vol. 23(4) pp. 615-631

46 Chakrabarti R. and Scholnick B., Exchange Rate Expectations and FDI Flows, in Center for

International Business Education and Research 2000 - 2001 Working Paper Series 47

Tondel L (2001) p. 10


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2. Studies that reject theory that macroeconomic instability

deters FDI

A number of scholars have rejected the theory that macroeconomic instability

negatively affects FDI, largely arguing that FDI is in fact a substitute for trade

and as such macroeconomic instability actually promotes FDI. Mundell

(1957), for example, used the basic international trade theory to repel the

notion that exchange rate volatility deters FDI. He states that because of

barriers to trade and migration, as well as variations in factor endowments

between countries, the incentives for FDI are greater in times of exchange

rate volatility. Consequently international trade and international factor

movements are substitutes and not complements. Others holding the same

view are Goldberg and Kolstad (1995), and Cushman (1985 and 1998).

Some scholars, among them Negishi (1985) and Sung and Lapan (2000),

have rejected the theory on the basis that exchange rate volatility actually

encourages the use of FDI as hedging device. Sung and Lapan (2000)

analysed the impact that exchange rate volatility has on foreign direct

investment of a risk-neutral firm. They showed that where there is sufficient

exchange rate volatility, the firm can increase profits by opening new plants in

foreign countries. They also show that this will prevent entry into competition

by local competitors. Their study had key assumptions of a risk neutral

investor, and that a firm can open new plants in the two countries, each time

with decreasing average costs.48

Goldberg and Kolstad (1995) did empirical analysis of quarterly U.S. FDI flows

with Canada, United Kingdom and Japan to see whether there is any

correlation between increase in exchange rate volatility and the share of

production capacity. Their study confirmed the hypothesis and concluded that

with risk averse investors, they will locate some of their productive capacity

48

Sung and Lapan (2000) p. 423


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abroad when exchange rate volatility increases, rejecting the notion that

macroeconomic volatility deters FDI.

3. Studies that mend the missing link

As it has been shown above, there exist contradictions on the evidential effect

that macroeconomic instability has on FDI. It therefore calls for answers as to

why this difference in views.

Aizenman (1992) and Goldberg and Kolstad (1995) point out that actually, the

exchange rate movements may be influenced by the same underlying

variables as sales abroad. Russ (2008) complements this observation by

arguing that the missing link that can explain the conflicting findings is the

presence of the underlying macroeconomic forces that influence both the

exchange rate and the value of sales by overseas branches. To prove this

point, Russ (2008) assumes there are two countries, heterogeneous, with

complete bond market, sticky prices, local sunk costs and risk-averse

consumers.

Thus, the difference in positions on the relationship between exchange rate

volatility and FDI emanates from the source of the volatility.

II. Legal environment uncertainty

A few studies have been conducted on the impact that legal uncertainty has

on FDI. Among them Seidman A., Seidman R., and Walde T. (1999), Tshuma

L. (1999), Shihata I. (2000), Salacuse J. (2000), Cukrowski and Kavelashvili

(2001), and Mogilevsky and Khasanov (2001) and Baniak A. et al (2002) who

researched mostly in Central and Eastern Europe after the collapse of the

USSR.

Most of the authors state that legal certainty is a key determinant of foreign

direct investment as it forms base of a market economy and “creates


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foundations for the development of strategic policies of domestic enterprises

and potential investors.”49 Baniak et al (2002), for example, modelled the

impact of stability of the legal environment on the pattern of FDI and showed

that high volatility of business regulations makes the inflow of FDI smaller and

that legal instability leads to adverse selection of the investors.

A number of other authors including Hewko J. (2002), however, believe that

although legal stability is desirable to attract foreign investment, it is not the

most important determinant.50 In the following paragraphs, we will look

summarily at what various authors have written about the impact of legal

environment certainty.

Shihata I. (2000) and Salacuse J. (2000) discuss the role of transaction costs

in discouraging foreign investment in developing countries. They enumerate

that because the legal environments in poor and developing countries are

underdeveloped and subject to frequent changes, they make strategic

investment planning and decision making costly.51 World Development Report

(2002) gives comparative weight of the legal and institutional transparency to

attracting and retaining foreign investors.

Hewko J (2002) analysed the relationship between FDI and the rule of law. He

said developing countries must establish a well functioning legislation in order

to attract FDI. He attributes the low FDI flows into Eastern Europe and former

Soviet Union countries to an incomplete legal reform process. Hewko further

looked at how FDI could stimulate change in the rule of law.

Seidman A., Seidman R., and Walde T. (1999) proposed a model for building

sound national legal and institutional frameworks that would attract and retain

investors, both local and foreign, with institutional and good governance as

49 Baniak A. et al (2002), p. 10 50 See Hewko J (2002) P.7 51 See Shihata I.F.I., Legal Framework for Development: Role of the World Bank in Legal Technical Assistance, in International Business Lawyer, September 1995, pp. 360–68. Also Salacuse J., Direct Foreign Investment and the Law in Developing Countries, in ICSID Review, vol. 15, no. 2 (Fall 2000), pp. 382–400


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yardsticks.52 Tshuma L. (1999) documented the institutional theory applicable

in developing countries and international institutions.53

A number of studies on legal stability have been conducted in Central and

Eastern Europe. Cukrowski and Kavelashvili (2001), for example, gave a

detailed analysis of legislative changes in Georgia. They found that because

Georgia, just like many former Soviet Union countries, did not manage to

reorganise their legal system following the collapse of the USSR they lost

many potential investors to countries that reformed their legal system.

Mogilevsky and Khasanov (2001) took the analysis further by estimating the

legislative stability in the Kyrgyz Republic, taking into account the number of

amendments that were made to the laws and the number of laws that became

invalid within a period of ten years following the collapse of the USSR.

Mogilevsky and Khasanov (2001) found that the most changed or amended

laws were those affecting foreign investment, henceforth the investment

climate unstable and unattractive to foreign investors.54

The above mentioned experience of Central and Eastern Europe is not

different from many other parts of the world. In “Foreign Direct Investment:

Does the Rule of Law Matter,” Hewko J. (2002) enumerates that during the

90s, developing and post-communist countries embraced construction of

programmes aimed at facilitating legal reform as key to the achievement of

economic growth and consolidation of democracy. He further states that this

legal and judicial reform emerged as “a crucial new priority of the international

aid community….including bilateral aid agencies, multilateral development

banks, and nongovernmental aid organizations”55 Hewko (2002) argues that

foreign investors have influence on the legal reform because they are not

52 See Ann Seidman, Robert B. Seidman, and Thomas Walde, “Building Sound National Frameworks for Development and Social Change,” in Seidman et al., eds., Making Development Work: Legislative Reform for Institutional Transformation and Good Governance, Boston: Kluwer Law International, 1999 53 See Tshuma L., The Political Economy of the World Bank’s Legal Framework for Economic Development, in Social and Legal Studies, vol. 8, no. 2 (1999), pp. 75–96 54 See Mogilevsky R. and Khasanov (2001) GDN Explaining Growth, in Global Research Project: Kyrgyz Republic 55 Hewko J. (2002) p. 1


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“passive spectators of the reform process, hesitant to enter the fray until a

modification or overhaul of the legal system has occurred.”56

Hewko’s view is corroborated by the World Bank (1999) which concluded that

“the massive move by developing and transition countries toward market

economies necessitated the adoption of strategies for the encouragement of

private investment, domestic and foreign.”57 The World Bank further states

that “naturally, there was a general realization that such an objective could not

be achieved without modifying and, sometimes, completely overhauling the

legal and institutional framework and firmly establishing the rule of law,

thereby creating the necessary climate of stability and predictability.”58

Although legal stability is one of the determinants of FDI, many authors agree

that establishing such desired stability is complicated for most developing

countries. Hewko J. (2002) gives five reasons for this assertion: (1) that

legislative and institutional reform is an organic process not conducive to easy

or quick solutions; (2) that levels of appreciation of adjustment of legislative

framework differs with large multinational investors from small entrepreneurial

investors; (3) foreign investors are not passive spectators but active

influencers in the legislative reform process; (4) international community

championing for general legal reforms creates false expectation since once

the reforms have been made at country level, they prove to be inapplicable

and call for further changes to detail realities on the ground; and (5) the

process of obtaining consensus on what foreign investors want is

burdensome and foreign investors use their own resources to identify their

own specific risks and problems relating to their investments.59

In terms of the weight of legal stability as a determinant of FDI, it has been

established that it is not the key determinant. Ramasatry, Slavova and

Berntein (1999) surveyed market perceptions of corporate governance

executives and found that perceptions of legal stability come second to

56 Hewko J. (2002) p. 3 57 World Bank (1999), Initiatives in Legal and Judicial Reform, Washington, D.C.: International Bank for Reconstruction and Development, p. 1 58 Ibid p.2

59 For more information, see Hewko J. (2002) p. 4-5


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business opportunities that exist in the host country.60 Ramasastry et al

(1999) confirmed the superiority of business opportunities over legal certainty

when they studied investment flows in Moldova after changing laws to fit into

the European Union standards. Agarwal (1996) found that despite inadequate

legal systems in Central and Eastern Europe after communism, FDI came

in.61 Perry (2000a) qualifies Agarwal’s finding by stating that investor size

plays a role in how the investor will function in a foreign legal environment. He

says small investors are likely to use informal ties and thus not get concerned

with the existence of a modern, efficient legal system. In another angle,

Lankes and Venables (1996) argue that increased FDI into countries that

have progressed in legal reform assists export-oriented industries.

Nevertheless, legal certainty gives confidence to investors that they will be

able to plan and execute decisions within levels of prediction of the conduct of

the state. The importance of legal certainty was well articulated by Franz

Bohm (1989) who said legal certainty is manifestation that in the particular

economy “the one who has power has no right to be free and the one who

wants to be free should have no power.”62

In view of the above, this paper establishes that legal stability is important to

FDI, but that the degree of its importance depends on the existence of real

business opportunities in a particular host country, the overall first perception

that foreign investors have of a host country, and the stage in the investment

decision i.e. if an investor is already established in the host country, he will be

interested more in legal situation than when the investor is yet to establish in

the host country.

60 See Ramasatry et al (1999) p. 32 - 39 61 See Agarwal and Prasad (1996) pp. 150–63 62 See Bohm F. in Moschel W(1989) p. 146


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Chapter Five: Foreign Direct Investment

Environment in Malawi

In order to properly locate the framework within which the hypothesis in this

paper is premised, the paper appraises the foreign direct investment climate

in Malawi. In this section, we introduce the political economy of Malawi, the

developments in the macroeconomic and legal environments and the

associated flows of foreign direct investment.

The importance of FDI cannot be overemphasised since a lot of literature

shows that of all developing countries the fastest growing economies are

those with most foreign direct investment inflows.63 This assertion is further

proven by Bergsman, Broadman and Drebentson (2000) who show that one

percentage increase in FDI brings about, ceteris paribus, an extra 0.8

percentage point increase in per capita income.64

I. The Malawi Political Economy

Malawi is a landlocked country located in South East Africa and is surrounded

by Tanzania to the north-east, Mozambique to the South and South-east and

Zambia to the west.

Malawi has 13.1 million inhabitants65 and in 2008 the country had GDP per

capita of US $210,66 maintaining the country’s classification as one of the

poorest countries in the world.67 85% of the population lives in the rural

areas.68 The National Statistics Office puts the poverty headcount for Malawi

63 See World Investment Report: 2002 64 See Bergsman, Broadman and Drebentsov (2000) 65 According to the 2008 Preliminary results of Population and Housing Census released by National Statistics Office on November 10 2008 and found at http://www.nso.malawi.net last visited on 2 May 2009 66 Over the past 5 years, Per Capita GDP has been hovering at an average of US$ 200 67 World Bank, Debt Relief at the Heavily Indebted Poor Countries (HIPC) Initiative Completion Point and Under the Multilateral Debt Relief Initiative (MDRI), page 1 68 Government of Malawi, Malawi Growth and Development Strategy, page 14


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at 40%69 and the World Bank (2009) states that it will not be possible for

Malawi to achieve more than half of the Millennium Development Goals

(MDGs) by 2015 despite the country being on track with the goals on Gender

Equality, Under-five Mortality, Combating HIV and AIDS and other diseases,

and Developing Global Partnership for Development.70

Malawi attained independence from Britain in 1964. For 31 years thereafter,

the Malawi economy was centrally controlled by the government of late Dr.

Hastings Kamuzu Banda. Kamuzu was Life President of the then only allowed

political party called the Malawi Congress Party (MCP). In 1994 Mr. Bakili

Muluzi became State President after winning the first multiparty democratic

elections under the ticket of the United Democratic Front (UDF). Muluzi’s rule

brought both political and market reforms, but is often referred to as a ‘lost

decade’71 due to the underdevelopment of the economy from 1994 to 2004.

After 10 years in power, Muluzi was succeeded by Dr. Bingu Wa Mutharika of

the same UDF party, who later dumped the party that ushered him into power

and formed his own party - the Democratic Progressive Party (DPP).

Mutharika won his second term presidency in the May 2009 general elections

and his party commands more than two-thirds majority in parliament.72

Malawi is member to a number of international and regional communities and

agreements. Among them the African Union (AU), the Africa Caribbean and

Pacific (ACP) group, the African Development Bank (AfDB), the

Commonwealth, Food and Agriculture Organisation (FAO), Group of 77 (G-

77), International Monetary Fund (IMF), the World Bank, World Trade

Organisation (WTO), the United Nations (UN), International labour

Organisation (ILO), and many others.73

69 National Statistics Office, 2008 Welfare Monitoring Survey, page 4 70 World Bank, Malawi Country Brief on http://go.worldbank.org/PH14P64710 last visited on 6 May 2009 71 See Muula A and Chanika E (2005) 72 For more information, see www.mec.org.mw/Elections/2009ResultsReports/tabid/98/Default.aspx last visited 25 May 2009 73 Other groups to which Malawi is member are IAEA, IBRD, ICAO, ICCt, ICRM, IDA, IFAD, IFC, IFRCS, IMO, Interpol, IOC, ISO (correspondent), ITU, ITUC, MIGA, MONUC, NAM, ONUB, OPCW, UNCTAD, UNESCO, UNIDO, UNMIL, UNMIS, UNWTO, UPU, WCL, WCO, WFTU, WHO, WIPO, WMO


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Specific to Africa, Malawi is member of the Common Market for Eastern and

Southern Africa (COMESA)74 and the Southern Africa Development

Community (SADC).75 It must be noted that there is some membership and

programme overlap between COMESA and SADC.76 SADC was formed in

1980 and has a vision of a “common future, within a regional community that

will ensure economic well-being, improvement of the standards of living and

quality of life, freedom and social justice, peace and security for the peoples

of Southern Africa.”77 Under SADC, Malawi is undertaking a number of

investment ventures together with this regional economic block. SADC has a

Finance and Development Protocol, a key tool for integration of the region

aimed at attracting and retaining foreign investors. The regional grouping is

also implementing joint investment promotion programmes with the European

Union.78

COMESA region covers 12 million square kilometres. Malawi is member of

this grouping which has 19 member states with total population of over 389

million and an annual import bill of around US$32 billion with an export bill of

US$82 billion.79 COMESA members launched a Regional Investment Agency

(RIA) in 2006, and adopted an investment agreement for COMESA Common

Investment Area, which envisions a free investment area by 2010. In 2009

COMESA launched a Customs Union. Malawi is also part of the implementers

of the African Development Bank – Export-Import Bank of China

Memorandum of Agreement aimed at providing co-financing or guaranteeing

for public sector and possible private sector investment projects in COMESA

region.80

74 Other members of COMESA are Burundi, Comoros, D.R. Congo, Djibouti, Egypt, Eritrea, Ethiopia, Kenya, Libya, Madagascar, Mauritius, Rwanda, Seychelles, Sudan, Swaziland, Uganda, Zambia and Zimbabwe 75 Other SADC member countries are Angola, Botswana, the Democratic Republic of Congo (DRC), Lesotho, Madagascar, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe 76 Eleven COMESA members are also members of SADC, while seven of SADC members are not in COMESA 77 For more information, see www.sadc.int last visited on 20 June 2009 78 See www.sadc.int (last visited on 21 June 2009) and UNCTAD, World Investment Report 2008. 79 From www.comesa.int last visited on 20 June 2009 80 For more information, see www.comesa.int last visited on 20 June 2009


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After Malawi attained independence in 1964 from Great Britain, the

government prioritised improvement of infrastructure, education system and

agriculture.81 Over one hundred and fifty state owned companies were set up,

covering almost every sector of the economy.82 Malawi’s economy was closed

from international competition and government controlled most

macroeconomic fundamentals such as exchange rates, and interest rates.

From the late 60s to early 80s, Malawi experienced boom. Analysts have

described that boom as “not … free and neutral” because the environment

entailed extensive state participation and government regulation of market

indicators.”83 Mhone (1992) writes that the “Malawi government … deliberately

manipulated market indicators by making them ‘wrong’ so as to maximise

accumulation and growth while ensuring that state enterprises led the market

with regard to investment trends.”84

Government’s major industrial and commercial policy was for promotion of

easy, labour intensive “import substitution into mass consumer goods and

processing of primary products..…and the promotion of local indigenous

Malawians into domestic trade.”85 Whiteside (1989) said of Malawi’s industrial

strategy that “Malawi probably has the least coherent policy towards

industrialisation of all Southern African countries. Its investment incentives

offer less than any other country and it has attracted very little foreign

investment …. The industrialisation took place with internally generated

capital.”86

Unlike the neighbouring Tanzania, Malawi did not attempt a socialist society.

However in 1978 government instituted an Economic Africanisation Policy

which targeted Malawians of Asian origin and limited their business and

residence to urban areas. This affected many of the nation's businesses.

From the late 1970s, following the break out of civil war in Mozambique, 81 See Mhone G, Malawi t the Crossroads: The Post-Colonial Political Economy, (1992), 82 For more information, visit www. Privatisationmalawi.org last visited on 3 April 2009 83 Mhone G, p. 20-25 84 Ibid p.22 85 Ibid p.20 86 Whiteside A. Industrialisation and Investment Incentives in Southern Africa, 1989


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Malawi access to the sea was hugely hampered. In addition Malawi became

home to over a million refugees from the neighbouring Mozambique.87 This

made Malawi a less attractive destination for FDI.

In 1994, Malawi became a multiparty democracy, and with it came official

liberalisation.88 The multiparty government committed itself to market

economy to the extent of incorporating it in the Constitution.89 Immediately

afterwards, the government developed in 1995 a Policy Framework Paper

(1995 – 1998) that defined policies aimed at promoting economic stabilisation,

broad-based economic growth, and higher rate of social development.

Government trade policies favoured export-oriented manufacturing. Beginning

February 1994 Malawi floated the Malawi Kwacha, embarked on Export

Processing Zones incentives in 1995; signed a bilateral trade agreement with

Zimbabwe in 1995 and reduced the base surtax from 30% to 20% in 1996.

National Privatisation Programme was started in 1996 targeting over 80

companies. The Malawi Kwacha was devalued in 1999, a year before Malawi

joined the COMESA Free Trade Area in 2000 where tariffs on intra-trade were

reduced by 60 to 90 percent, allowed imports of finished goods from member

countries duty free, while imports of raw materials and intermediate goods

from other countries attracted duty.

II. The Macroeconomic Environment

Malawi’s economy is agricultural-based with the agriculture sector providing

80% of the export earnings and employing 80% of the work force.90 The

87 See Malawi’s history at www.zum.de/whkmla/region/southafrica/malawiind.html last visited on 19 June 2009 88 Much as liberalisation was not acknowledged in Malawi government, several changes were already happening such as devaluation of the Malawi Kwacha in early 80s. 89 Section 13(n) of the Republic of Malawi (Constitution) Act, 1994 (No. 20 of 1994) 90 Government of Malawi, Malawi Growth and Development Strategy (2005) page 14


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sector contributes 39% of the GDP.91 According to the Doing Business Report

(2004) 91% of Malawi’s agricultural exports are raw commodities. This heavy

dependence on raw agricultural commodities for exports has made the

country vulnerable to fluctuations in world commodity prices, over which the

country has no control; and has for a long time tied aggregate real GDP

growth to fluctuations in the climatic conditions. This is evidenced by the drop

of Real GDP (at factor cost) in years when the country experienced drought

such as in 1998, 2000, and 2001.

Although agriculture sector has been making significant contributions to

Malawi’s GDP since independence, services remains the highest contributor

to the country’s GDP at 44.3% in 2006. See Table 1 below for more

information.

Table 1: Sectoral Percentage contribution to GDP

%age Contribution to GDP 1

994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Agriculture 24.8 30.4 34.7 32.6 35.6 37.8 39.5 38.8 39 35.7 34.9 31.3 32.4 Mining and Quarying 0.5 0.4 1.8 1.3 1.3 1.3 1.4 1.6 1 1.1 1.2 1.8 1.3

Manufacturing 17.1 15.8 14.3 13.5 13.6 13.4 12.9 11.5 11.3 10.3 10.1 10.6 10.4 Electricity and Water 1.6 1.4 1.3 1.3 1.4 1.3 1.4 1.4 1.4 1.8 1.9 2.1 2

Construction 2.2 2 2 2 2 2.2 2.2 2.2 2.4 4.4 4.3 4.8 5 Ownership of Dwellings 1.7 1.6 1.4 1.4 1.4 1.4 1.4 1.5 1.5 4.7 4.5 4.7 4.6

Services 52.2 48.4 44.5 47.9 44.7 42.5 41.1 43 43.4 42.1 43 44.8 44.3

Distribution 27.1 24.3 22 24.1 22.3 21.1 20.9 22 21.9 15.9 16.9 18.6 18.6 Transport and Communication 5 5.1 4.3 4.4 4.3 4.4 4.2 4.3 5 6.2 6 6.5 6.4 Financial and Professional Services 6.7 6.5 7.1 9 8.2 7.9 8 8.1 8.5 8.4 8.5 8.9 9.7 Private Social and Community Services 2.3 2 2 2.1 2.1 2 2.1 2.2 2.2 9.6 10.2 10.4 9.9 Producers of Government Services 14.1 13.3 11.8 11.2 10.6 10 9 9.4 9.2 6.9 6.9 6.8 6.5 Unallocable Finance Charges -3 -2.9 -2.7 -2.9 -2.7 -2.9 -2.9 -3.1 -3.4 -4.9 -5.6 -6.4 -6.9

GDP at Factor Cost 100 100 100 100 100 100 100 100 100 100 100 100 100 Source: Various Government of Malawi: Annual Economic Reports 1997, 2000, 2003, and 2006

91 Malawi Investment Promotion Agency on http://www.malawi-invest.net/inves_opp_agri.html last visited on 7 May 2009


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From 1994 to 1997, Malawi enjoyed stable economic growth following the

government’s adherence to prudent policies and adherence to the structural

adjustment targets, and the subsequent increased balance of payments

support, moderately good rains and no major commodity price shocks.92

By late 1997 however, government of Malawi relaxed its expenditure controls

and missed the commitments it had under the Enhanced Structural

Adjustment Facility (ESAF) of the International Monetary Fund (IMF) resulting

in the suspension of the programme.93 In year 2000, the country got into a

support programme with the IMF under the Poverty Reduction and Growth

Facility (PRGF) aimed at restoring macroeconomic stability. This programme

however also went off track in end 2001 due to fiscal slippages and this led to

donors withholding budgetary support. The government resorted to domestic

borrowing to finance its increasing budget deficit, a situation that made the

country’s debt service to government revenue ratio reach record high of

29.3% in 2001 and amounted to two and half times the amount of total output

in the period 1995-2002. 94

During the period 2000 – 2003, the manufacturing sector showed the fastest

fall. The sector which grew by 5.5% in 1995 declined to growth rate of -3% in

2000 and further –14.2% in 2002.95 The poor performance of the sector had

been mainly due to an adverse macroeconomic environment, which had been

characterized by instability of the exchange rate accompanied by high lending

interest rates averaging 43%. (See figure 1 and 4 for Interest Rates and Real

Effective Exchange Rate respectively.

In 2001 the government launched the participatory process of developing the

Malawi Poverty Reduction Strategy Paper (MPRSP), a blueprint for national

prioritisation aimed at meaningfully reducing poverty by empowering the poor.

The MPRSP was launched in April 2002 and it was its successful

92 CIDA (1998), p. 3 93 IMF, Malawi: Staff Monitored Programme, IMF Country Report No. 04/295, September 2004 94 Government of Malawi, Economic Report (2002) 95 Government of Malawi, Economic Report (2002)


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implementation that saw Malawi qualify for debt cancellation under the

Multilateral Debt Relief Initiative (MDRI).96 Stakeholders, particularly from the

private sector, in the development of the Malawi Economic Growth Strategy

(MEGS) observed that the MPRSP was more for distribution than for

generating growth and hence viewed as insufficient to achieve a sustained

annual economic growth of at least 6 percent required to reduce poverty by

half by the year 2015.97 Consequently, government developed the Malawi

Economic Growth Strategy (MEGS), a pro-private sector strategy to

supplement the MPRSP. MEGS was aimed at stimulating private sector

investment and trade. In 2005 the government combined the MPRSP and

MEGS and produced a hybrid strategy called the Malawi Growth and

Development Strategy (MGDS), which to-date is a key development guide for

Malawi until 2010.

Since change of government in 2004, Malawi’s economy is ‘registering fast

growth and development.’98 From 2005 to 2008 the country’s real GDP growth

has averaged 6.53%, up from an average of 1.03% from year 2000 to 2003.99

Inflation is fast being contained towards single digits down from the range of

83.1% in 1995, to 44.3% in 1999 further to 7.2% in 2008. See figure 1 below

for details.

96 Multilateral Debt Relief Initiative provided to eligible Highly Indebted Poor Countries (HIPC) 100% relief on eligible debt from the IMF , World Bank and the African Development Bank. 97 See Malawi Economic Growth Strategy (2004), p. 10 98 For more information, see World Bank at http://go.worldbank.org/PH14P64710 and IMF Press Statement at http://www.imf.org/external/np/sec/pr/2009/pr09105.htm both last visited on 2 May 2009. 99 The real growth rates for Malawi were as follows: 2.2% in 2000; -4.1% in 2001; 2.1% in 2002; 3.9% in 2003; 4.9% in 2004; 5.7% in 2005; 6.4% in 2006; 6.8% in 2007 and 7.2% in 2008. Source: http://www.malawi-invest.net/stats_economy.html last visited on May 6 2009


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Figure 1: Real Growth Rates, Inflation Rates and Interest Rates for

Malawi

-10

0

10

20

30

40

50

60

70

80

90

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Year

Percentage

Real Growth Rate Inflation Rate Interest Rate - Lending Rate

Source: National Statistics Office Year Book 2000, 2004, 2008; Malawi Economic Growth Strategy Vol. 2 (2006), and MIPA (2008)

Malawi’s 2008 inflation of 7.2% is the third best in Southern and Eastern

Africa after Botswana and South Africa.100 Malawi is also registering fast

growth, with real growth rate of 7.2% in 2008, up from -4.1% in 2001 (see

figure 1). The International Monetary Fund estimates that in 2009 Malawi’s

growth will be 9.7%101 and The Economist forecasts Malawi to be the 2009

second fastest growing economy in the world after Qatar.102

The International Monetary Fund (2006) described Malawi as “just recovering

from a fiscal crisis” in year 2006.103 Fiscal deficits as percentage of total

government expenditure had lowered down from 27% in 2003/2004 to 14% in

2005/2006. This was supported by cancellation of 90% of Malawi’s external

debt amounting to US$2.97 billion under the MDRI from the IMF, World Bank

and Africa Development Bank after the country reached the Heavily Indebted

Poor Countries (HIPC) Completion Point in September 2006. The IMF and

100 See Standard Bank Group Economics (2008) report which puts Angola’s inflation rate at 12.3%, Botswana at 7.03, Democratic Republic of Congo at 16.9%, Kenya at 26.5%, Lesotho at 8.0%,Mauritius at 9.7%, Mozambique at 8.2%, South Africa at 7.1%, Uganda at 11.9%, Zambia at 12.4% and Zimbabwe at 12,562.7% 101 IMF, Statement At The Conclusion of An IMF Staff Mission To Malawi, Press Release No. 09/105 102 http://www.economist.com/world/international/displaystory.cfm?story_id=13278585 last visited on 16 March 2009 103 See IMF Article IV report 2000-2004 and 2005-2009


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World Bank initiative was followed by a further debt cancellation by bilateral

creditors in October 2006, thus reducing Malawi's total foreign debt to less

than US$480 million.104

The aforementioned developments in the Malawi economy were directly

correlated to the behaviour of Real Effective Exchange Rates for the period

1994 to 2008. As discussed in section 1 of Chapter Four above, Real

Effective Exchange Rates is an important international variable that helps

explain the state of a country’s macroeconomic stability.

This paper is mindful of the caution that Zanello and Dominic (1997) gave that

the use of REER can be tricky and hence we need to be cautious with the

evaluation. This is so because different choices of index, choice of base year,

the method of calculation and relative short-run and long-run movements in

countries under consideration give varying results.

In this study, we use the computed annual Consumer Price Index (CPI) and

Wholesale Price Index (WPI) for Malawi from 1994 to 2008 obtained from the

International Financial Statistics published by the IMF, the Reserve Bank of

Malawi (RBM) and National Statics Office (NSO). In the computed indices, the

base year is 1994 (1994=100). The weights are based on trade in

manufactures, primary commodities and tourism services over the years and

take into account bilateral trade flows as well as third market competition, as

stylised by the International Monetary Fund. This methodology is similar to the

one used by the European Central Bank (ECB).

The real effective exchange rate for Malawi can be expressed as:

}wij

PjRj

PiRi

ijREER

≠=

∏

104 Malawi Government Budget Document No. 4a, 2007


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Where, Pi is Malawi’s price index, Ri nominal exchange rate of the Malawi

Kwacha in US dollars, Pj price index of country j, Rj nominal exchange rate of

country j’s currency in US dollars, and Wij country j’s weight for Malawi.

Following are Real Exchange Rates for Malawi for period 1994 to 2008, with

1994 base year.

Figure 2: Real Effective Exchange Rates for Malawi (1994 - 2008)

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Year

Real Effective Exchange Rate

Real Effective Exchnage Rates for Malawi (1994 - 2008)"

Source: IMF International Financial Statistics, Reserve Bank of Malawi and National Statistics office

Figure 2 above shows that the Malawi Kwacha has been fluctuating over time,

but with an average trend of real depreciation for the period 1994 - 2008.

REER stability was experienced briefly in years between 1998 and 1999; and

from 2003 to 2006. Malawi Kwacha depreciated in years 1994 – 1995; 1997 –

1998; 2002 – 2003; and from 2006 -2008. The Malawi Kwacha appreciated

from 1996 – 1998; and from 2001 – 2002.

From the above discussion on the Malawi economy, studying macroeconomic

instability in Malawi would have to combine developments in a number of

variables among them interest rates, inflation and REER. But REER being an

international price, inflows of FDI are related more to REER than would

domestic interest rates or inflation rates alone.


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III. The Legal Environment

As it has been described in Chapter Four above, legal certainty gives

confidence to investors that they will be able to plan and execute decisions

within levels of prediction of the conduct of the state. The legislature makes

the laws which the executive implements and the judiciary determines

whether particular action is within the meaning of the law. In Malawi, the

President is both Head of State and Government as such he has powers

under section 90 of the Republican Constitution to issue any directive or

decree that has the effect of law. In addition, a resolution passed in the

national assembly becomes law only when the President assents. Cabinet

Ministers also have powers under the relevant Act of Parliament to issue

decrees in form of regulations and licence requirements that they see

appropriate for the execution of relevant policies under their ministries.

Section 11(2) of the Tobacco Act, for example, empowers the Minister to fix

prices for the tobacco. Therefore in looking at the certainty of legal

environment, this paper accommodates the determinations of the legislature,

and decrees of the Cabinet and the State President.

An environment of legal certainty is available when stakeholders have the

opportunity to know and operate their programmes with predictability of what

the law says. The stable environment is also available where proposed bills

that are known to the public turn into their fruition. Therefore, frequent

changes to laws, frequent introduction of new laws, frequent decrees, and

lengthy or frequent rejection of bills expected by the public smack of legal

uncertainty.

In this section, the paper will look at what has transpired in the Malawi legal

environment from 1994 to 2008. The discussions will be limited to laws that

are related to business investment. This information will help us understand

behaviours of FDI in Malawi in the prescribed period.


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1. Amendment of investment related laws in Malawi

The paper clusters the years under study into three sets: 1994-1998, 1999-

1993 and 2004-2008. The clustering is significant in that the starting years on

1994, 1999 and 2004 were Presidential and Parliamentary election years.

Consequently, the ensuing years were fertile years for reviewing, repealing

and / or introducing new laws and decrees.

Between 1994 and 2008, the Malawi Parliament made 467 amendments to

the laws of Malawi. Of these, 318 concern investment, representing 68.9% of

all amendments.105 This shows that laws that directly affect investors were

subject to most amendments. 13.21% of these amendments to investment-

related laws were made between 1994 and 1998; 61.01% between 1999 and

2003; and 25.78% between 2004 and 2008. The following Table 2 gives list of

investment-related laws that were amended between 1994 and 2008:

Table 2: Investment Related Laws amended between 1994 and 2008

Law Amendments Law

Amendments

Taxation 46 Labour Relations 2 Customs and Excise 38 Insurance 2 Corrupt Practices Act 25 Export Processing Zones 2 Constitution 17 Employment 2 Inland Waters Shipping 14 Electricity 2

Aviation 13 Automotive Trades Registration and Fair Practices 2

Land 13 Banking 2 Surtax (Later Value Added Tax) 12 Workers' Compensation 1 Companies 8 Trademarks 1

Finance and Audit 8 Treaties and Conventions Publication 1

Copyright 7 Stamp Duties 1 Immigration 7 Tea CESS 1 Pharmacy, Medicines and Poisons 7 Tourism and Hotels 1 Business Licensing 5 Public Enterprises (Privatisation) 1 Control of Goods 5 Public Procurement 1 National Roads Authority 5 Rural Electrification 1 Estate Duty 4 Money Laundering, etc 1

105 See various Malawi Government Gazettes from 1994 to 2008; and the Laws of Malawi Volumes I to X


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Land Survey 4 National Road Safety Council 1 Weights and Measures 4 Public Audit 1 Bretton Woods Agreement 3 Deeds Registration 1 Business Names Registration 3 Energy Regulation 1 Dangerous Drugs 3 Environment Management 1 Exchange Control 3 Export Promotion Council 1 Malawi Revenue Authority 3 Gaming 1 Occupational Safety, Health and Welfare 3

Liquid Fuels and Gas (Production and Supply) 1

Pesticides 3 Investment Promotion 1 Registered Designs 3 Mines and Minerals 1 Malawi Development Corporation 2 Adjudication of Title 1 Patents 2 Biosafety 1 Public Finance Management 2 Building Societies 1 Registered Land 2 Communication 1 Statutory Bodies 2 Competition and Fair Trading 1 WaterWorks 2 Cooperative Societies 1 TOTAL 318

Source: Malawi Government Gazettes from 1994 to 2008; Laws of Malawi Volumes I to X.

Of the laws in Table 2 above, it is clear that the most amended investment-

related laws, in their order of frequency, were: Taxation; Customs and Excise;

Corrupt Practices; Constitution; Inland Shipping; Aviation; Land; Value Added;

Companies; Finance and Audit; Copyright; Immigration; Pharmacy, Medicines

and Poisons; Business Licensing; Control of Goods; National Roads

Authority; Estate Duty; and Land Survey. Graphically, Figure 3 below shows

Taxation Act, Customs and Exercise Act, Corrupt Practices Act and the

Constitution as the most amended:


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Figure 3: Most Amended Business-related Laws in Malawi: 1994 -

2008

0

10

20

30

40

50

60

70

Aviatio

n

Busines

s Li

cens

ing

Com

panies

Con

stitu

tion

Con

trol o

f Goo

ds

Cop

yright

Cor

rupt

Pra

ctices

Cus

tom

s an

d Exc

ise

Estat

e Dut

y

Finan

ce a

nd A

udit

Imm

igra

tion

Inla

nd S

hipp

ing

Land

Land

Sur

vey

Nat

iona

l Roa

ds A

utho

rity

Pharm

acy, M

edici

nes an

d Poi

sons

Taxat

ion

Value

Add

ed

Law

Number of Amendments

Source: Malawi Government Gazettes from 1994 to 2008; Laws of Malawi Volumes I to X,

with author’s own calculation

These frequent and high number of amendments meant that the investors

were uncertain about the requirements of the aforementioned laws. Between

1994 and 1998, 7 amendments were made to the Taxation law; 6 to the

Customs and Excise law; and 5 amendments to the Constitution, representing

16.67%, 14.29% and 11.90% of amendments for the period respectively.

Between year 1999 and 2003, the Customs and Excise law was the most

amended law at 26, followed by the Taxation act with 16 amendments. From

2004 to 2008, Parliament made 24 amendments to the Corrupt Practices

Act, 22 amendments to the Taxation law, 10 amendments to the Value Added

Tax law.

Table 3 gives the top three laws that were amended most in their respective

years.


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Table 3: Top-3 most amended laws in 1994-1998, 1999–2003 and 2004-2008.

Period

Law Amendments

1994 – 1998 1999 – 2003 2004 – 2008

Taxation 7 16 22

Customs and Excise 6 26 6

Constitution 5 5 7

Value-Added 0 2 10

Corrupt Practices 1 0 24

Source: Malawi Government Gazettes from 1994 to 2008; Laws of Malawi Volumes I to X.

The preparation of this paper preceded consultations that the author held with

Malawi Confederation of Chambers of Commerce and Industry (MCCCI), the

Economics Association of Malawi (ECAMA), the Indigenous Business

Association of Malawi (IBAM) and the Malawi Investment Promotion Agency

(MIPA) on FDI related laws in Malawi. The respondents were purposefully

selected because they represent the views of the larger membership of their

groupings while MIPA interacts with investors on day-to-day basis. All of the

interviewees, i.e. MCCCI, ECAMA, IBAM and MIPA, said that there is urgent

need to amend relevant laws which would facilitate carrying out of business

easier. Following is a list of the laws that MCCI, ECAMA, IBAM and investors

submitted to the Ministry of Justice as requiring urgent amendment:106

(A) Industrial Development Laws: (1) Export Incentives Act, cap

39:04 of the Laws of Malawi, (2) Investment Promotion Act, cap 39:05

of the Laws of Malawi, (3) The Export Processing Zones Act, cap 39:06

of the Laws of Malawi, (4) The Public-Private partnership Development

Bill, 2008

(B) Commercial and Trade Laws: (1) The Arbitration Act, cap 6:03 of

the Laws of Malawi, (2) The Control of Goods Act, cap 18:08 of the

Laws of Malawi, (3) The Taxation Act cap 41:01 of the Laws of Malawi,

106 As compiled by Anchor Mooring Partners and Nicholas Andrew Towle for the Government of Malawi Ministry of Justice, 2008, and confirmed by author through interviews


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(4) The Business Licensing Act, cap 46:01 of the Laws of Malawi, (5)

The Business Names Registration Act, cap 46:02 of the Laws of

Malawi, (6) The Companies Act, cap 46:03 of the Laws of Malawi, (7)

The Competition and Fair Trading Act, cap 48:09 of the Laws of

Malawi, (8) The Communications Act, cap 68:05 of the Laws of Malawi

(C) Employment-Related Laws: (1) The Immigration Act, cap 15:03 of

the Laws of Malawi, (2) The Labour Relations Act, cap 54:01 of the

Laws of Malawi, (3) The Employment Act, cap 55:01 of the Laws of

Malawi, (4) The Retirement Funds Bill, 2008

(D) Land Ownership Laws: (1) The Land Act, cap 57:01 of the Laws

of Malawi, (2) The Registered Land Act, cap 58:01 of the Laws of

Malawi, (3) The Conveyancing Act, cap 58:03 of the Laws of Malawi,

(4) Land Acquisition Act, cap 58:04 of the Laws of Malawi, (5)

Customary Land (Development) Act, cap 59:01 of the Laws of Malawi.

(E) Agriculture Commodities Laws: (1) The Tobacco Act, cap 65:02

of the Laws of Malawi, (2) The Cotton Act, cap 65:04 of the Laws of

Malawi.

(F) Financial Services-Related Laws: (1) Banking Act, cap 44:01 of

the Laws of Malawi, (2) Banking Bill, 2007 (to replace the Banking Act),

(3) The Reserve Bank Act, cap 44:02 of the Laws of Malawi, (4) The

Capital Market Development Act, cap 46:06 of the Laws of Malawi, (5)

The Securities Bill, (6) The Payments Systems Bill, (7) The Micro-

Finance Bill, 2007, (8) Credit Reference Bureau Bill, 2008, (9)

Insurance Bill, 2008, (10) Financial services Bill, 2008, (11) The

Financial Cooperative Bill, 2008

(G) Security-Related Laws: (1) Corrupt Practices Act, cap 7:04 of the

Laws of Malawi, (2) The Money Laundering, Proceeds of Serious crime

and Terrorist Financing Act, 2008, (3) The National Registration Bill,

2008


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(H) Intellectual Property Laws: (1) The Trademarks Act, cap 49:01 of

the Laws of Malawi, (2) The Patents Act, cap 49:02 of the Laws of

Malawi, (3) The Copyright Act, cap 49:03 of the Laws of Malawi, (4)

The Registered Designs Act, cap 49:05 of the Laws of Malawi

Asked to prioritise the above mentioned laws and bills in need of Parliament’s

passing, MCCI, ECAMA, IBAM and investors through MIPA prioritised the

laws as follows:107

Table 4: Priority Laws by investors and stakeholders

Priority Law

High Business Licensing Act; Employment Act;

Trademarks Act; Copyright Act; Patents Act; Registered Designs Act;

Immigration Act; Business Names Registration Act; Taxation Act;

Export Incentives Act; Export Processing Zones Act; Communications

Act; Capital Market Development Act;

Medium Competition and Fair Trading Act; Labour Relations Act; Customary

Land Act; Land Acquisition Act; Banking Act: Reserve Bank Act;

Payment Systems Act; Arbitration Act; Cotton Act; Tobacco Act;

Low Corrupt Practices Act; Money Laundering Act;

The Control of Goods Act

Source: Government of Malawi BESTAP report, 2008

In addition, the stakeholders state that they cooperated with the development

of the following bills which they agreed to be very important for investment in

Malawi: Investment and Export Promotion Bill; Public-Private Partnership

Development Bill; Financial Services Bill; Securities Bill; Microfinance Bill;

Banking Bill; Financial Cooperatives Bill; Insurance Bill; Retirement Funds Bill;

Credit Reference Bureau Bill; and National Registration Bill.108 Business

players waited therefore for opportunity for Parliament to discuss and pass the

107 For detailed report, see Government of Malawi Ministry of Justice, Business Environment Strengthening Technical Assistance Project, Report on Prioritisation of Economic Laws for Revision, 2008 108 See Government of Malawi BESTAP Report, 2008


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bills into laws. The bills, however, were either rejected by the opposition-

dominated parliament or withdrawn by government before passing. This

caused anxiety among investors.

Comparing the laws that Parliament amended and what investors expected

Parliament to pass, it becomes apparent that there is a huge discrepancy.

Only four out of the sixty-six laws that were amended fall within the priority

interests of the business sector, namely Business Licensing Act, Copyright

Act, Immigration Act and Taxation Act.

The views of the MCCCI, ECAMA and IBAM are that although 68% of the

amendments made in parliament between 1994 and 2008 were related to

investment laws, “so far the amendments made were not what were required

to improve investment climate in Malawi…. In fact the amendments only made

making business more difficult.”109

Another respondent summed up the private sector frustration when he said

“most regulations being used now are outdated. Instead of reviewing pro-

business laws, parliament is amending the not-so-important laws and

rejecting new important bills.”110 He was referring to the failure by parliament

to pass the Financial Services Bill in the 2005-2008 period. The parliament

sitting of 2008 was scheduled to debate and pass 13 business related bills

namely The Public-Private Partnership Development Bill, The Retirement

Funds Bill, The Securities Bill, The Payments Systems Bill, The Micro-Finance

Bill, Credit Reference Bureau Bill, Insurance Bill, Financial services Bill, The

Financial Cooperative Bill, The National Registration Bill, The Appropriation

Bill, National Water Development Bill and Electricity Inter-Connection Bill.

Only the Appropriation Bill was passed but after over four months of debates

and threats in parliament amidst debates on whether section 65 of the

constitution should be implemented before the budget is passed.111 The World

109 Interview with Victor Alex, Executive Secretary of the Gala Tobacco Company on17 March 2009 110 Interview with Mr.Fanuel Kum’dana, Executive Director of the Banker’s Association of Malawi. On 29 March 2009. 111 Section 65 of the Malawi Constitution says any Member of Parliament who was elected on a ticket of a political party represented in parliament, and joins another political party represented in


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Bank has the following impression of Malawi Parliament: “The 2004-2009

parliamentary season ended up being one with the fewest meetings

characterized by uphill battles for bills to be passed.” 112

When bills are known or expected by the public but are being frustrated by

parliament, it contributes significantly to the legal uncertainty. Mr. Bamusi of

the Human Rights Consultative Committee said “with the current parliament,

we cannot tell which law they will wake up angry with and amend.”113

The legal environment was uncertain, particularly from 1999 to 2008 albeit in

different ways. Over 55% of amendments to investment-related laws were

made in between 1999-2003. Not only were investment related laws

frequently amended, but the amendments put more controls on investors. The

period 2004 – 2008 had 90% of all the bills that were either rejected or

withdrawn since 1994. The bills that the investors worked on with the Ministry

of Justice to have them passed by parliament were shelved, while parliament

discussed and passed bills that were not on the agenda.

2. Presidential and Ministerial Decrees

Apart from the laws that are passed in parliament, FDI decision making is

affected by decrees made by the State President and/or Cabinet Ministers.

Section 90 of the Constitution of the Republic of Malawi gives power to the

State president to make any decrees that he deems to be in the interest of the

nation. Additionally, under specific Acts of Parliament, Cabinet Ministers have

power to make decrees that have effect of law. Under the provision of Section

3 of the Control of Goods Act, Chapter 10:08 of the Laws of Malawi, for

example, the Minister of Industry, Trade and Private Sector has powers to

make decrees that prohibit and restrict the importing and exporting of any

parliament, loses his seat as member of parliament. At that material time, over 75 members had joined the newly formed Democratic People’s Party (DPP), which is the party that the State President Dr. Bingu Wa Mutharika formed after he dumped the party on which he became president of Malawi. 112 World Bank on http://go.worldbank.org/PH14P64710 last visited on 6 May 2009 113 Interview with Mr. Mavuto Bamusi, National Director for the Human Rights Consultative Committee on 4 April 2009.


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goods. Similar decrees are made by Minister of Agriculture, Minister of Health

and others.

There are also other pieces of legislation that are used to effect licences for

importation of certain goods. These include the Firearms and Ammunition

Ordinance, which is administered by the Minister of Home Affairs and Internal

Security through the Inspector General of Police; the Dangerous Drugs

Ordinance, which is administered by the Minister of Health and Population,

and the Merchandise Marks Act which prohibits importation of goods bearing

forged marks or false trade descriptions, or marked with offending marks in

terms of the Act. The Minister of Agriculture can also make decrees on

minimum prices for particular goods, which must be complied with.

Since 1994, import decrees have been made on 15 products namely: clothing

and uniforms for the police and army, radioactive materials, mist nets for

capturing wild birds, wild animals and related products, fish, compound

products containing flour and meal residues, poultry and related products,

meat and meat products, dielrin, aldrin, kitchen and table salt, Portland

ordinary cement, cane sugar, wheat flour, and fertilisers. In order to import the

aforementioned goods, one required to apply to the responsible minister for

import licence which was valid for six months and could be renewed once

upon acceptable explanation.

There were also decrees made on 11 goods for export namely: Implements of

war, atomic energy and materials used in production of arms and ammunition,

petroleum products, wild animals and animal products, maize,

unmanufactured tobacco, tea, scrap metal, cotton, soya beans and rice.

Export licences are valid for three months and can be renewed to another

three months at the discretion of the relevant Cabinet Minister. Figure 6 below

gives decrees that were given every year from 1994 to 2008.


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Figure 6: Presidential and Ministerial Decrees in Malawi:

1994-2008

0

2

4

6

8

10

12

14

16

18

20

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Year

Number of decrees issued

Export decree Import decree

Source: Ministry of Trade and Private Sector Development, Ministry of Agriculture, Malawi Revenue Authority, Malawi Confederation of Chambers of Commerce and Industry

A total of 172 decrees have been recorded on imports and 134 on exports

from year 1994 to 2008 representing 56.21% and 43.79% respectively. Years

2001 and 2008 recorded the highest number of decrees of 18 each made on

imports while the highest exports decrees were issued in 2006. Year 2006

saw the highest combined import and export decrees at 32. The period 2004-

2008 saw the highest total decrees at 139, of which 76 were on imports. See

Table 5 below for details:

Table 5: Aggregate Decrees on imports and exports: 1994 - 2008

1994-1998 1999-2003 2004-2008 1994-2008

Import Decrees 30 66 76 172

% of total import decrees 51.72% 60.55% 54.68% 56.21%

Export decrees 28 43 63 134

% of total export decrees 48.28% 39.45% 45.32% 43.79%

TOTAL NUMBER 58 109 139 306

Source: Ministry of Trade and Private Sector Development, Ministry of Agriculture, Malawi Revenue Authority, Malawi Confederation of Chambers of Commerce and Industry

The fact that Ministers have the power to decide to relax the decrees that they

made on imports and exports on a case-by-case basis meant that business

persons were not certain whether they would be allowed to transact in the

concerned product. Since year 2000, decrees on imports increased by


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80.23% while decrees on exports increased by 76.87%, with 46.48% and

40.57% of the decrees on imports and exports respectively being issued

between 1999 and 2004.

3. Legal Environment Uncertainty Index for Malawi

With the findings enumerated above on legal amendments by Parliament and

Presidential and Ministerial decrees, we construct composite Figure 7 below

for comparison.

Figure 7: Investment Related Law Amendments

and Decrees in Malawi: 1994 - 2008

0

20

40

60

80

100

120

140

160

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Years

Number of Amendments and Decrees

Bills Rejected by or withdrawn from Parliament Presidential and Ministerial DecreesInvestment related law amendments All Law amendments

Source: Government of Malawi Ministry of Justice and Constitutional Affairs, Ministry of Trade and Private Sector Development, Ministry of Agriculture, Malawi Revenue Authority, Malawi Confederation of Chambers of Commerce and Industry

Further, we can determine the level of certainty of the legal system in Malawi

by applying the Legal Environment Uncertainty Index (LEUI).114

Legal Environment Uncertainty is determined by:

114 This index is an adaptation of the Legal Environment Stability Index first developed by Mogilevsky and Khasanov (2001).The difference here being that in the LEUI there is inclusion of bills that were expected to be tabled by parliament but were either rejected or withdrawn prematurely.


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++=

N

NeNdNaLECI

Where Na is the number of amendments made to the laws in the succeeding

years; Nd is the number of Presidential and Cabinet decrees made in the

succeeding years; Ne is the number of bills expected to be passed in

Parliament but were rejected or withdrawn and N is number of laws and

decrees adopted in the period under study.

The index falls in the range of 0 to 1, with 1 being the most uncertain legal

environment. Applying the index to years the 1994-1998; 1999-2003 and

2004-2008, we get the following results in Figure 8:

Figure 8: Legal Uncertainty Index 1994-1998, 1999-2003;

2004-2008

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

1994-1998 1999-2003 2004-2008

Years

Legal Uncertainty Index


Accumulatively, Malawi experienced legal environment uncertainty in all the

three clusters of years. The explanation to the uncertainty in the period 1994-

1998 is that since Malawi had just turned a multiparty democracy, the period

was for repealing of the old one-party government led laws and formulation of

new laws to fit the multiparty democracy. The period had the least number of

presidential and ministerial decrees and also least number of expected bills

rejected or withdrawn from parliament.

The period 1999-2003 saw the most amendments made to the laws by

parliament. 73% of all amendments made between 1994 and 2008 were done


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in this period. This increase in amendments may be a sign that the laws that

were developed in the first multiparty government were of low quality as they

may have been developed by non-experienced legislators and that

government realised after some years of implementation the need to amend

the laws to become best fit with the developments of the New Republic.

Baniak et. al (2002) said this is ‘typical of transitional economies.”115 36% of

all presidential and ministerial decrees were also made in this period. Only 2

bills out of total 20 were withdrawn from Parliament.

Malawi’s legal environment was most uncertain from 2004 – 2008 with

uncertainty index of 0.73. This uncertainty came largely from parliament’s

rejection or withdrawal of expected bills at 90% of the occurrence; followed by

presidential and ministerial decrees contributing 45% of all decrees in the

study period. Only 18% of all amendments to the laws were made in this

period. In this period, the political party in government - the Democratic

Progressive Party (DPP) had a minority in Parliament. Therefore government

business was frustrated in the National Assembly by the opposition political

parties, which controlled over 60% of the votes in the August House, leading

to either rejection of government bills, or government just withdrawing the bills

before parliament tabled them.

Figure 9 below gives a year-to-year contribution to the legal environment

uncertainty in Malawi from 1994 to 2008. Years 2000 and 2003 made the

biggest single contribution to legal environment uncertainty in Malawi at 19%

and 15% respectively.

115 Baniak et al (2002), p. 8


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0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

Uncertainty Index

1994 1996 1998 2000 2002 2004 2006 2008

Years

Figure 9: Year-to-Year Contribution to the Legal Environment

Uncertainty

Uncertainty Index on All Laws and Decrees Uncertainty Index in Investment Laws and decrees



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IV. The Flow of Foreign Direct Investment in Malawi

Information on FDI in Malawi was first officially compiled in 1999 by the

Government of Malawi team comprising officials from the National Statistical

Office (NSO), Reserve Bank of Malawi (RBM), Malawi Export Promotion

Agency, Ministry of Finance, Ministry of Economic Planning and Development

and Ministry of Trade and Private Sector Development (formerly called

Ministry of Commerce). As such, FDI database in Malawi has little information

on pre-1999 period.116 Nevertheless, the author managed to supplement

relevant information from other non-governmental sources, including

UNCTAD.

So far, four official surveys have been conducted on FDI in Malawi. The first

covering the years 1999 to 2000; the second one covering years 2000 to

2001; the third covering 2001 to 2004; and the latest covered years 2005 to

2007. The first two surveys used a structured questionnaire to capture private

capital stocks and RBM Exchange Control Forms (E-Forms) to capture capital

flows. The use of the E-Forms proved however unsuccessful and subsequent

surveys therefore covered both stocks and flows, and “hence there is now a

coherent database spanning the period 2000 to 2003”117

The FDI data compilation in Malawi faces problems such as limited enterprise

coverage due to lack of regular updates to the FDI register; computation of

up-rating factors to blow the sample results to the population estimates;

inadequate submission of financial statements; and difficult book value

estimation - often companies report only share capital for book value,

excluding reserves and retained earnings.118

116 Interview with Mr. Machinjiri, the Commissioner General for the Malawi National Statistics Office on 27 February 2009 117 See Malawi report to UNCTAD Expert Meeting on Capacity Building in the Area of FDI: Data Compilation and Policy Formulation in Developing Countries, 12-14 December 2005, p. 3 118 For detailed discussion, see Machinjiri C, FDI Data Collection in Malawi, p. 3-5


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Compared to other countries in the SADC region, investment flows into

Malawi can be said to be small. The Malawi Economic Growth Strategy

(MEGS) (2004) states that Malawi’s past poor FDI performance was due to

poor macroeconomic environment.119 The government decision of 1971 to

amend the Companies Act by instituting section 3 to facilitate local

participation in foreign owned subsidiaries and foreign direct investment may

explain the trend of investment in Malawi.120 Although the then State

President His Excellency Dr. Hastings Kamuzu Banda explained that “there

can be no question of using it (the Companies Act) as a sort of ‘backdoor’

nationalism…(but that) Malawi cannot be allowed to be anyone’s commercial

or industrial policy,”121 investors continued to fear possibility of outright

nationalisation.122 Whiteside (1989) summed it well when he said “Malawi

investment incentives offer less than any other country and it has attracted

very little foreign investment …. The industrialisation took place with internally

generated capital.”123

Since Malawi embraced market economy in 1994, Government of Malawi has

put in place investment policies that allow investors both local and foreign to

invest in any sector of the economy without restrictions on ownership, size of

investment, source of funds or whether the product is destined for foreign or

domestic markets. Malawi has taken initiatives aimed at creating an investor

friendly environment and attract more FDI, among them the repeal of the

Forfeiture Act in 1992. Government also officially eliminated price controls,

terminated import restrictions and the need for import licences, and embarked

on privatisation of state-owned companies. Government also has special

incentives for investors in the sectors prioritised by the government namely

Manufacturing, Tourism, Mining, Agriculture and horticulture, Infrastructural

development and Information technology.124

119 MEGS Vol. II, 2004, p.1 120 The Companies Act, Section 3, was amended in 1971/72 to provide powers legalising local purchase of equity in foreign owned companies 121 See Malawi Hansard, 9-16 March 1971, p.839 122 Silumbu E., Foreign Trade Policies and performance in Malawi 1965 – 1990, in Mhone, 1992 123 Whiteside A. Industrialisation and Investment Incentives in Southern Africa, 1989 124 MIPA, Investors Guide to Malawi, 2007


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Furthermore, Malawi signed double taxation treaties with Denmark, the

Netherlands, France, South Africa, the United Kingdom, Norway, Sweden and

Switzerland. The country is a member of the International Convention for the

Settlement of Investment Disputes (ICSID) and also member of the

Multilateral Investment Guarantee Agency (MIGA).

Investing in Malawi is facilitated by the Malawi Investment Promotion Agency

(MIPA), a body established by an Act of Parliament. MIPA facilitates tax

incentives as enshrined in the main tax legislations that include the Customs

and Excise Act, the Income Act and the Export Processing Zones (EPZ) Act,

to encourage investment. The incentives apply equally to both domestic and

foreign investors and are aimed at encouraging development that will

enhance gross domestic product, be of net benefit to the nation’s foreign

exchange reserves and expand employment opportunities. The main thrust of

investment incentives comes through the tax system, directly and indirectly.

In relation to other countries in the SADC region, in the year 2000, Malawi

stood at number 10 out of 14 (behind Mozambique and ahead of Zimbabwe)

in terms of attractiveness to FDI.125 Its trade tariffs were confirmed to be on

the decline to -15.6%, -12.1% and -19.9% on all products, primary products

and manufacturing products respectively in 2000 from 1995 rates.126

Major FDI into Malawi largely comes from South Africa, China, France, India,

United Kingdom, Taiwan, United States of America, Germany, Italy, Kenya,

Lebanon, Libya, United Arab Emirates and Zimbabwe, in their order of

importance.127 Most of the FDI goes into the sectors of Agriculture,

Manufacturing, Services, Tourism and Mining, in their order of importance.

Since 2000, 30% of FDI comes in form of Merger and Acquisition, 49%

Greenfield, while 21% is other.128

125 See World Bank 2001a, World Economic Forum 2000 126 See Malawi Investment Promotion Agency, Trade and Investors, 2008 127 See Malawi Investment Promotion Agency, Trade and Investors, 2008 128 UNCTAD, FDI/TNC Database 2008


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Before the liberalisation of Malawi’s economy in 1994, the country’s annual

FDI inflow averaged US$20.4 million.129 This proportion was about 15% of

GDP and so too small to generate the growth of 6% per annum that the

Government targeted.130 The United Nations Industrial Development

Organisation (UNIDO) calculated that an average growth rate of 6% would

require an investment rate of 33% of GDP, including domestic savings and

Overseas Development Assistance.131 The following Table 6 gives FDI inflows

and stock for Malawi from 1994 to 2008.

Table 6: MALAWI FDI Inflows (in US$ at current prices in Millions)

Year FDI Flow (US$ Millions)

FDI Flow Per Capita (US$)

FDI Stock (US$ Millions)

FDI Stock per Capita (US$)

1994 24.99 2.51 224.76 22.60

1995 5.64 0.56 230.4 22.83

1996 15.8 1.53 246.2 23.86

1997 14.87 1.40 261.07 24.61

1998 12.1 1.11 273.17 24.97

1999 58.53 5.19 331.7 29.39

2000 39.6 3.41 357.7 30.77

2001 41.4 3.47 419.01 35.08

2002 16.73 1.36 390.49 35.08

2003 26.83 5.24 409.93 32.60

2004 107.71 8.35 562.34 44.72

2005 26.5 2.02 503.02 39.01

2006 185.3 2.21 535.62 43.81

2007 92.06 7.14 590.26 45.79

2008 143.25 10.94 764.51 58.36

Source: UNCTAD FDI Statistics; Malawi Investment Promotion Agency, National Statistics Office

As shown in Table 6 above, between 1994 and 1998, FDI inflow to Malawi

amounted to US$ 73.41 million. From 1999 to 2003, FDI inflow increased to

US$ 183.07 million and from 1994 to 2008, FDI inflow into Malawi stood at

US$ 554.82 million.132 Of the FDI flows in 2004-2008, 73% went to the mining

sector while 23% went into manufacturing133

Overall, Malawi’s recorded FDI inflows have been fluctuating and increasing

over time. See Figure 10 below.

129 Malawi Economic Growth Strategy 2005, p. 106 130 Ibid, p. 106 131 UNIDO, Foreign Investment Perceptions in Sub-Saharan Africa, 2002 132 See UNCTAD Statistics at http://stats.unctad.org/FDI/TableViewe.aspx?ReportId=1254 133 Investors’ Guide to Malawi, 2007, P. 15


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Figure 10: FDI Inflows to Malawi: 1994-2008

0

20

40

60

80

100

120

140

160

180

200

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Year

US$ m

illions (at current

prices)

FDI Inflows to Malawi: 1994-2008

Source: UNCTAD FDI Statistics; Malawi Investment Promotion Agency, National Statistics Office

It is possible to relate the pattern of FDI inflows as given in Figure 10 above to

the developments in the legal and macroeconomic environment. As it has

been discussed in Chapter Five section II above, Malawi experienced

macroeconomic instability in late 90s and early 2000 and stabilised from

1995. This paper also established in Chapter Five section III above that

Malawi’s legal environment has been uncertain since 1994, but that the

causes of the uncertainty have varied. It appears therefore that there is a

relationship between FDI inflows, macroeconomic stability and legal

environment. However the level of influence than each of the later two has on

FDI has not been established yet. In the next chapter, we will use regression

analysis in order to confirm or reject the hypothesis of the paper that

macroeconomic instability negatively affects FDI inflow more than legal

environment uncertainty does in Malawi.


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Chapter Six: Testing The Hypothesis

In this chapter, we test the hypothesis that macroeconomic instability

negatively affects foreign direct investment inflows more than legal

environment uncertainty does in Malawi. The hypothesis is significant in that

in this time of globalization, many different countries offer similar conditions to

attract the same FDI. As such policy makers need to prioritise the

determinants that will effectively bring in FDI.

The pattern of FDI flows in Malawi observed in Chapter Five above shows

that both macroeconomic instability and legal environment uncertainty affect

FDI flows. There is a negative correlation between FDI inflow and

macroeconomic instability, and also between FDI inflow and legal

environment uncertainty. We will now test to see which of the two affects FDI

more than the other.

I. Methodology

Here follows, we will run standard OLS multivariate regression134 presented

below to test whether in Malawi, macroeconomic instability affects FDI flows

more than does legal environment uncertainty:

Y = α + βE + γX + ε

where Y is FDI inflow; α is a constant; β is the effect of Real Effective

Exchange Rate; E is Real Effective Exchange Rate; γγγγ is the effect of Legal

Environment Uncertainty; X is the legal environment uncertainty index; and

εεεε is the “noise” term reflecting other factors that influence FDI inflow.

In this study, we are primarily interested in the relative importance between

macroeconomic instability and legal environment uncertainty. Running the

regression135 above gives the results in Table 7:

134 in EA/LimDep 8.0


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II. Results

Table 7: Results of Model A

Variable Coeff. Std.Err. t-ratio P-value

REALEFFE -1.37445 0.515881 -2.66427** 0.0206279 LEGALUNC -19.8138 310.464 -0.06382 0.950164 Constant 182.469 56.7254 3.21671 0.00739944

R2 = 0. 0.393747 ** significant at 5% Where REALEFFE = Real Effective Exchange Rate, and LEGALUNC = Legal

Environment Certainty Index.

The results show that 39% of the variation in FDI is explained by the

regression equation above. Although the R square is less than 50%, the

model nevertheless can be used to predict FDI flows in Malawi as it is above

30%.136 With t-ratio at less than -2, the results show that we can predict that

Real Effective Exchange Rate is a good predictor of FDI in Malawi. In

addition, with P= 0.0206279, the model tells that macroeconomic instability

has an observed significance level of 95%, confirming that it is a more

significant determinant of FDI compared to the legal environment uncertainty.

The above model produces a high t-ratio but a lower R Square. In addition, it

is the unexplained constant variable that has observed significance level at

95%. This suggests that other variables that have statistically significant effect

on FDI are not in the model. As a test and control measure, we introduce

other variables in the model namely Trade Balance, Interest Rates, Inflation

Rates and Real Growth Rates for Malawi. Running a standard OLS

multivariate regression as in Model A produces Model B results in Table 8 as

follows:

135 Details of the variable are in Annex 1 136 Steven Silbiger in: The 10-Day MBA, 2005 Revised, Riakhus, London, states on page 189 that an R Square of 30% is considered very high since in practical economy there are many variables that could affect economies.


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Table 8: Results of Model B

Variable Coeff. Std.Err. t-ratio P-value

Constant 97.3663 117.512 0.828564 0.431375 TRADEBAL -0.0669931 0.0637023 -1.05166 0.323682 REALEFFE -0.689669 0.907846 -0.759676 0.46924 INTEREST 0.360213 1.47951 0.243468 0.81377 INFLATIO -0.519577 0.956036 -0.54347 0.601618 REALGROW 0.741746 2.22313 0.333649 0.747221 LEGALUNC -94.2344 393.992 -0.239178 0.816981

R2 = 0.608121 Where TRADEBAL = Trade Balance; REALEFFE = Real Effective Exchange

Rates; INTEREST = Interest rates; INFLATIO = Inflation Rates; REALGROW

= Real Growth Rates; and LEGALUNC = Legal Environment Certainty Index.

In this model B, unlike in Model A above, 61% of the variation of FDI can be

explained by this regression equation. However, none of the independent

variables in Model B has statistically significant effect on FDI.137 Nevertheless,

Real Effective Exchange Rate has a bigger value (P = 0.46924) compared to

Legal Environment Uncertainty (P = 0.816981), suffice that neither of them is

significant.

The above findings show that macroeconomic instability is a more important

variable than legal environment uncertainty. The finding confirms the

hypothesis of this study that macroeconomic instability negatively affects

foreign direct investment inflows more than legal environment uncertainty

does in Malawi

137 There is no independent variable with t-ratio larger than 2 and less than -2.


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Chapter Seven: Conclusion

This paper has confirmed the hypothesis that macroeconomic instability


environment uncertainty does in Malawi. This has been done after running

standard OLS multivariate regression on data that the author collected on

Malawi, after discussing the determinants of FDI, theories around the

activities of FDI and reviewing previous empirical findings.

Although the empirical analysis that was ran for this paper was limited to

testing the aforementioned hypothesis, the process has revealed that there is

need for more research into the factors that affect FDI in Malawi and other

developing countries. The analysis has shown that it is possible that Real

Effective Exchange Rate in itself is not sufficient measure of macroeconomic

instability, as has been traditionally associated. Adding more variables to

REER and legal uncertainty to our model diluted the significance of REER. It

would have been more instructive to test the effect of a combined variable

comprising REER, interest rate and inflation, for example. But because that

was not the scope of this study, we pack it as an area for more research.

Through this paper, it has been confirmed that macroeconomic instability


environment uncertainty does in Malawi.


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Annex 1. RESULTS OF REGRESSION ANALYSIS

+-----------------------------------------------------------------------+

| Ordinary least squares regression Weighting variable = none |

| Dep. var. = FDIINFLO Mean= 54.08733333 , S.D.= 53.94103599 |

| Model size: Observations = 15, Parameters = 3, Deg.Fr.= 12 |

| Residuals: Sum of squares= 24695.64686 , Std.Dev.= 45.36486 |

| Fit: R-squared= .393747, Adjusted R-squared = .29270 |

| Model test: F[ 2, 12] = 3.90, Prob value = .04965 |

| Diagnostic: Log-L = -76.8316, Restricted(b=0) Log-L = -80.5850 |

| LogAmemiyaPrCrt.= 7.812, Akaike Info. Crt.= 10.644 |

| Autocorrel: Durbin-Watson Statistic = 2.41128, Rho = -.20564 |

+-----------------------------------------------------------------------+

+---------+--------------+----------------+--------+---------+----------+

|Variable | Coefficient | Standard Error |t-ratio |P[|T|>t] | Mean of X|

+---------+--------------+----------------+--------+---------+----------+

REALEFFE -1.374448670 .51588130 -2.664 .0206 92.625742

LEGALUNC -19.81379226 310.46381 -.064 .9502 .54140395E-01

Constant 182.4693873 56.725387 3.217 .0074

-->

REGRESS;Lhs=FDIINFLO;Rhs=ONE,TRADEBAL,REALEFFE,INTEREST,INFLATIO,REALGROW

,LEGALUNC$

************************************************************************

* NOTE: Deleted 1 observations with missing data. N is now 15 *

************************************************************************

+-----------------------------------------------------------------------+










+-----------------------------------------------------------------------+

+---------+--------------+----------------+--------+---------+----------+


+---------+--------------+----------------+--------+---------+----------+

Constant 97.36631733 117.51210 .829 .4314

TRADEBAL -.6699313145E-01 .63702254E-01 -1.052 .3237 -326.32939

REALEFFE -.6896687606 .90784591 -.760 .4692 92.625742

INTEREST .3602129543 1.4795080 .243 .8138 39.348000

INFLATIO -.5195766720 .95603645 -.543 .6016 25.033333

REALGROW .7417462164 2.2231311 .334 .7472 3.6066667

LEGALUNC -94.23436659 393.99236 -.239 .8170 .54140395E-01

(Note: E+nn or E-nn means multiply by 10 to + or -nn power.)

--> SAVE;file="C:\Program Files\Es\LIMDEP\Program\collins.lpj"$

-->


,LEGALUNC,X10$

************************************************************************


************************************************************************


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Error: 131: Models - Regression; regressors are collinear.

-->


,LEGALUNC$

************************************************************************


************************************************************************

+-----------------------------------------------------------------------+










+-----------------------------------------------------------------------+

+---------+--------------+----------------+--------+---------+----------+


+---------+--------------+----------------+--------+---------+----------+

Constant 97.36631733 117.51210 .829 .4314

TRADEBAL -.6699313145E-01 .63702254E-01 -1.052 .3237 -326.32939

REALEFFE -.6896687606 .90784591 -.760 .4692 92.625742

INTEREST .3602129543 1.4795080 .243 .8138 39.348000

INFLATIO -.5195766720 .95603645 -.543 .6016 25.033333

REALGROW .7417462164 2.2231311 .334 .7472 3.6066667

LEGALUNC -94.23436659 393.99236 -.239 .8170 .54140395E-01

(Note: E+nn or E-nn means multiply by 10 to + or -nn power.)


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2. QUESTIONNAIRE:

THE POLITICAL ECONOMY OF FOREIGN DIRECT INVESTMENT IN MALAWI Master Thesis for Collins Magalasi Master of Law and Business Bucerius Law School / WHU Otto Beisheim School of Management, Germany

SECTION 1: GENERAL INFORMATION Background information of the respondent:

a) Name of the company: b) Year started in Malawi: c) Contact Person: d) Telephone number: e) Email address: f) Date of the response:

What industry are you in?

a) Agriculture (incl. Fishing, Livestock) b) Tourism and hospitality c) Manufacturing d) Services e) Trading Consumer goods (includes also consumer durables and retailing) f) Healthcare, pharmaceuticals and biotechnology g) Energy and mining h) Utilities i) Construction and real estate j) Entertainment, media and publishing k) Financial services (non-insurance plus insurance) l) IT services m) Professional services n) Telecommunication o) Transport p) Government public sector q) Other (specify)

What is your company’s annual turnover?

a) Under K50m b) K50m – K100m c) K100m - K250m d) K250m – K500m e) K500m – K1bn f) K1bn – K3bn g) Over K5bn

What countries do you export to, and in what goods and services? What countries do you import from, and in what goods and services?


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SECTION 2: FDI TRENDS What country does your Investment come from?

a) Latin America: __________________________________________ b) North America __________________________________________ c) Western Europe _________________________________________ d) Eastern Europe _________________________________________ e) Asia-Pacific ____________________________________________ f) Middle East & North Africa ________________________________ g) SADC Region __________________________________________ h) Other Sub Sahara Africa __________________________________

If you were to relocate the business, where would you go to, and why?

a) Latin America: __________________________________________ b) North America __________________________________________ c) Western Europe ________________________________________ d) Eastern Europe _________________________________________ e) Asia-Pacific ____________________________________________ f) Middle East & North Africa _________________________________ g) SADC Region ___________________________________________ h) Other Sub Sahara Africa __________________________________

How does your company’s total planned level of investment for the next five years compare with total investment over the past five years? And Why?

a) Over 100% increase in investment b) 50%-100% increase in investment c) 25%-50% increase in investment d) 10%-25% increase in investment e) Up to 10% increase in investment f) Same level of investment g) Up to 10% decrease in investment h) 10%-25% decrease in investment i) 25-50% decrease in investment j) 50-100% decrease in investment k) Over 100% decrease

If you were to make a fresh investment in Malawi, what would be the main forms of investment activity for your company in the next five years? Please rank each in order 1 to 5, 1 being the primary form of activity.

a) Follow-on investment in existing operations b) Joint ventures c) Mergers and acquisitions d) Greenfield investment e) Franchising


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Why did you choose Malawi for your FDI? a) New markets b) Low-cost inputs e.g. labour, raw materials c) Innovation, technology, New partnership possibilities d) Acquisition opportunities – e.g. privatisation e) Availability of natural resources f) Institutional Stability – macroeconomic g) Institutional Stability – legal and political h) Institutional Stability – standards, trade policy, vision,

Please rate the importance of the following factors on your decision to invest in the country between 1 and 5, 1 being extremely important & 5 being unimportant

a) skills in the labour market b) level of corruption and bribery c) quality infrastructure d) Quality of suppliers e) Geographic location f) Political stability g) Overall policy towards free business and competition h) Specific policies towards foreign investment i) Rule of law j) Stability of laws k) Enforcement of laws l) Presidential / government decrees m) Macroeconomic stability (Inflation, exchange rate n) Competition on the market o) Access to credit p) Tax regimes q) competition from local firms r) Red tape s) Market growth – size of market

Which of the following worry your company? (Please rate the following risks between 1 and 5, 1 being extremely significant and 5 being insignificant).

a) Skills in the labour market b) Level of corruption and bribery c) Quality infrastructure d) Quality of suppliers e) Geographic location f) Political stability g) Overall policy towards free business and competition h) Specific policies towards foreign investment i) Rule of law j) Stability of laws k) Enforcement of laws l) Presidential / government decrees m) Macroeconomic stability (Inflation, exchange rate n) Competition on the market o) Access to credit p) Tax regimes q) competition from local firms r) Red tape s) Market growth – size of market


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SECTION C: THE LEGAL ENVIRONMENT

What (How many) Laws, Policies, Presidential/Ministerial decrees or other having effect on FDI were introduced, approved / amended / in Year Details of Bill / Law/ policy

/ decree Details (Amended, passed, ordered)

1994 1995 1996 1997 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 What laws are of concern to you as a business? Please give the law that

is of high priority, medium priority and low priority.

What is your comment on laws that have been amended in Malawi?

How stable are the business-related laws in Malawi?

What laws are in need of amendment, and for how long?

Name the laws that you know have not been implemented objectively.

State any presidential or other decrees or decisions that affected your business decisions


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Respondents: a) Malawi Investment Promotion Agency

b) Malawi Confederation of Chambers of Commerce and Industry

c) Investors (purposefully chosen to represent Years of operation, Sector, Size)

a. In Malawi the past 1 year b. In Malawi the past 5 years c. In Malawi the past 10 years d. In Malawi more than 10 years e. Big corporations f. Medium scale corporations g. Small-scale business

d) Parliament

e) Government –

a. Ministry of Industry, Trade and Private Sector Development b. Ministry of Justice c. Ministry of Foreign Affairs d. Competition and Fair Trading Commission e. Law Commission f. Malawi Law Society

f) Judiciary –

a. Industrial Relations Court, b. High Court,

g) Reserve Bank of Malawi

h) Malawi Revenue Authority

i) International Monetary Fund

j) Economists Association of Malawi


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RESPONDENTS

Industrial

1. Illovo Sugar Malawi (South Africa)

2. Transglobe Produce Exports (Mali)

3. Valmore Paints (UK)

4. Limbe Leaf Tobacco Company Limited (USA)

5. Mandala Limited (UK)

6. Bata Shoe Company (Canada)

Tertiary (sales)

1. CFAO Malawi Limited(France)

2. Metro Cash and Carry Malawi (Germany)

3. Celtel Malawi Limited (Kuwait)

4. Gestener (Japan)

5. Alexander Forbes Mw Ltd (South Africa)

6. Continental Discount House Ltd (Mauritius)

7. The Cold Chain (Zimbabwe)

8. Lipton Tea (UK)

9. Hertz Corporation (US)

10. Macmillan Malawi Ltd (Germany)

11. Maaersk Malawi Ltd (Denmark)

12. Potland Malawi Ltd (France)

13. Pricewaterhousecoopers (USA)

14. Sara Lee Corporation (USA)

15. Xerographics (USA)

Finance

1. Standard Bank (South Africa)

2. AON Malawi Ltd (USA)


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AMENDMENTS TO LAWS OF MALAWI: 1994 – 2008

THE LAW 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 TOTAL 1994 - 1998

1999 - 2003

2005 - 2008

Penal Code 3 7 10 3 7 0

Corrupt Practices Act 1 24 25 1 0 24

Criminal Procedure and evidence Code 1 9 1 11 1 10 0

Extradition 1 1 0 1 0

Mutual Assistance in Criminal matters 1 1 0 1 0

Wills and Inheritance 2 1 3 6 3 3 0

Army 12 3 2 17 12 5 0

Malawi Citizenship 0 0 0 0

Immigration 4 3 7 0 7 0

Immunities and Privileges 4 4 0 4 0

Treaties and Conventions Publication 1 1 0 1 0

Statutory Bodies (Control of Contracts) 2 2 0 2 0

Control of Goods 2 3 5 0 5 0

Pharmacy, Medicines and Poisons 5 2 7 0 7 0

Dangerous Drugs 1 2 3 1 2 0

Pesticides 1 2 3 0 3 0

Medical Practitioners and Dentists 5 8 1 14 5 9 0

Nurses and Midwives 1 1 2 0 2 0

Finance and Audit 4 4 8 0 8 0

Government securities 0 0 0 0

Malawi Development Corporation 2 2 0 2 0

Export Promotion Council 1 1 0 1 0

Investment Promotion 1 1 0 1 0

Export Processing Zones 1 1 2 1 1 0

Malawi Revenue Authority 1 1 1 3 1 1 1 Investment Disputes (Enforcement of Awards) 0 0 0 0

Bretton Woods Agreement 1 2 3 0 3 0

Taxation 1 1 1 2 2 1 8 1 7 10 11 1 46 7 17 22


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Customs and Excise 5 1 9 2 6 9 2 4 38 6 26 6

Surtax (Later Value Added Tax) 1 1 1 9 12 0 2 10

Tea CESS 1 1 0 1 0

Stamp Duties 1 1 0 1 0

Estate Duty 2 2 4 2 2 0

Road Traffic 1 2 3 6 1 5 0

National Road Safety Council of Malawi 1 1 0 1 0

National Roads Authority 1 1 1 1 1 5 2 2 1

Aviation 1 6 6 13 1 12 0

Inland Waters Shipping 1 8 5 14 1 13 0

WaterWorks 1 1 2 1 1 0

Electricity 1 1 2 1 0 1

Constitution 1 2 1 1 1 4 7 17 5 5 7

Land 1 5 2 5 13 1 7 5

Business Licencing 1 4 5 1 4 0

Labour Relations 1 1 2 1 1 0

Business Names Registration 1 2 3 1 2 0

Building Societies 1 1 1 0 0

Companies 1 6 1 8 1 7 0

Insurance 1 1 2 1 1 0

Communication 1 1 1 0 0

Competition and Fair Trading 1 1 1 0 0

Employment 1 1 2 0 2 0

Workers' Compensation 1 1 0 1 0

Veterinary and Para-veterinary Practitio 0 0 0 0

Biosafety 1 1 0 1 0

National Parks and Wildlife 53 53 0 0 53

Weights and Measures 4 4 0 4 0

Commercial Credits 0 0 0 0

Trademarks 1 1 0 1 0

Patents 2 2 0 2 0


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Copyright 1 6 7 1 6 0

Registered Designs 3 3 0 3 0

Automotive Trades Registration and Fair Practices 2 2 0 2 0

Liquor 5 15 20 5 15 0

Banking 2 2 0 2 0

Exchange Control 2 1 3 2 1 0

Public Enterprises (Privatisation) 1 1 0 1 0

Gaming 1 1 0 1 0

Cooperative Societies 1 1 0 1 0

Public Audit 1 1 0 1 0

Public Finance Management 1 1 2 0 1 1

Public Procurement 1 1 0 1 0

Science and Technology 1 1 0 1 0

Prevention of Domestic Violence 1 1 0 0 1

Roads Fund Administration 1 1 0 0 1

Money Laundering, Proceeds of Serious Crime and Terrorist Financing 1 1 0 0 1

Tourism and Hotels 1 1 0 1 0

Supreme Courts 1 1 0 1 0

Energy Regulation 1 1 0 0 1

Rural Electrification 1 1 0 0 1

Liquid Fuels and Gas 1 1 0 0 1 Occupational Safety, Health and Welfare 2 1 3 0 3 0

Registered Land 2 2 0 2 0

Deeds Registration 1 1 0 1 0

Adjudication of Title 1 1 0 1 0

Land Survey 4 4 0 4 0

Environment Management 1 1 0 1 0

Mines and Minerals 1 1 0 1 0

39 8 3 8 14 12 143 8 8 87 94 15 14 0 14 467 72 258 137


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COMPOSITE LEGAL AMENDMENTS, BILLS AND INDEX

Year No. of All law amendments

No. of Investment related law amendments

No. of presidential and Ministerial Decrees

No. of bills rejected by / withdrawn from parliament

Stability Index in Investment Laws and decrees

Stability Index on All Laws and Decrees

1994 39 12 22 0 0.052795031 0.042875158

1995 8 8 11 0 0.029503106 0.023959647

1996 3 3 10 0 0.020186335 0.016393443

1997 8 7 7 0 0.02173913 0.017654477

1998 14 12 8 0 0.031055901 0.025220681

1999 12 3 7 0 0.01552795 0.01261034

2000 143 102 23 0 0.194099379 0.157629256

2001 8 8 27 2 0.057453416 0.04665826

2002 8 8 26 0 0.052795031 0.042875158

2003 87 73 26 0 0.153726708 0.124842371

2004 94 41 28 0 0.107142857 0.087011349

2005 15 14 23 3 0.062111801 0.050441362

2006 14 13 32 2 0.072981366 0.0592686

2007 0 0 26 4 0.046583851 0.037831021

2008 14 14 30 9 0.082298137 0.066834805

Total 467 318 306 20 1 0.812105927

644 1 1

1994-1998 72 42 58 0 0.155279503 0.5889029 1999-2003 258 194 109 2 0.473602484 0.662042875 2004-2008 137 82 139 18 0.371118012 0.72887768


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Collins Magalasi Bucerius Law School Berliner Tor 3 20099 Hamburg Germany 16 June 2009 The Solicitor General Ministry of Justice and Constitutional Affairs Capital City Lilongwe Malawi

Dear Madam/Sir,

REQUEST FOR INFORMATION

I write to seek your support in my accessing information on (a) list of new laws

that were passed in Parliament; (b) list of laws that were amended; and (c) list

of bills that were expected in parliament but were either not put to the floor, or

were rejected on the floor, or were contained to Committee level, or were

withdrawn, or were just not assented to by the State President. The period is

from 1994 to 2008.

I need this information to complete thesis for my academic studies of Law and

Business which I am doing with the Bucerius Law School in Germany. My

thesis is on The Political Economy of Foreign Direct Investment in Malawi.

Specifically, I am looking at the impact that legal (un)certainty has on foreign

direct investment. I am paying special attention to (a) industrial development

laws; (b) commercial and trade laws; (c) employment-related laws; (d) land

ownership laws; (e) agriculture commodities laws; (f) financial services-related

laws; (g) security-related laws; and (h) intellectual property laws.

Your support will therefore be greatly appreciated. I look forward to your usual

support and I thank you in advance for your help.

Yours sincerely,

Collins Magalasi

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