Foreign direct investment and economic growth in Africa

Doctoral Thesis


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University of Cape Town

Abstract Foreign direct investment (FDI) is a valuable source of external finance to complement domestic savings, enhance domestic investment and increase employment in developing countries. It can potentially promote long-term growth and development through knowledge and technology transfers from foreign firms to domestic agents in host countries. With these benefits in mind, especially in relation to low-income African countries characterized by underdeveloped domestic financial markets, this thesis investigates the determinants of FDI, evaluates how well local firms can be integrated in FDI projects to enhance productivity growth and determines whether these investments have contributed to increasing productivity growth of host African countries. These issues are analysed in three constituent chapters of the thesis. The first study explores whether FDI from the different group of economies, stratified into the Organization of Economic Cooperation and Development (OECD), non-OECD emerging markets and intra-African economies, are driven by market-seeking, natural resource-seeking and efficiency-seeking motivations into host African countries. Evidence suggests that market-seeking and efficiency-seeking FDI are more growth enhancing than natural-resource seeking FDI. This study exploits recent bilateral FDI data to examine the underlying motivations and determinants of FDI into African economies. In doing so, the study contributes to the empirical literature by providing evidence on the specific factors that influence FDI into resource-rich and non-resource rich African economies. The study finds that the size of host markets and presence of natural resources have important influence on FDI into resource-rich countries, with market size determining FDI into non-resource rich countries, while investments from non-OECD emerging markets economies are also explained by the presence of lower labour costs. It is also evident that there are significant differences in determinants of FDI into African countries, between investors from African economies and counterparts from the OECD and non-OECD emerging markets. The results show significant differences between the drivers of FDI to South Africa and other African countries. The second study complements the first in analysing the determinants of FDI activity, by determining the sectors through which foreign affiliates and local firms are more likely to undertake joint activities in FDI projects. This is important in light of the growing need to promote knowledge and technology transfers from FDI in order to boost productivity in host sub-Saharan African countries. Over the years, FDI in sub-Saharan Africa were mostly undertaken in high technology sectors, which are presumably capital-intensive, by jointventure firms formed between transnational corporations and domestic firms. This pattern of investment has called into question whether foreign affiliates and local firms have greater propensity to jointly engage in FDI projects in capital-intensive activities. Considering this question, the study contributes to the empirical literature by determining the sectors through which such integration is more likely to occur. In trying to understand this relationship, the analysis used a large survey dataset on manufacturing and services firms for 19 sub-Saharan African countries. The survey was conducted by the United Nations Industrial Development Organization (UNIDO) in 2010. This data allows us to evaluate the integration decisions of firms, considering how physical capital intensity of foreign affiliates and skill intensity of the local workforce affect such decisions. The results reveal remarkably consistent finding that there is a higher likelihood that these firms will integrate production through capital-intensive than labour-intensive activities in sub-Saharan Africa. The third study investigates the growth enhancing effects of FDI into African countries, considering whether such impact depends on human capital capacity across countries. This study contributes to the empirical literature by exploiting host country heterogeneity in human capital capacity in explaining whether there are differences in the effect of FDI on productivity growth across countries. To consider such differences, recent country level data on total factor productivity growth and human capital stock, which is used as proxy for host country absorptive capacity, were used in a panel of 25 countries over the period 1996-2011. The analysis employed the Panel Smooth Transition Regression (PSTR) which allows for host country heterogeneity in human capital capacity to determine whether the relationship between FDI and productivity growth is nonlinear. The results strongly support the nonlinearity between FDI and productivity growth. This suggests that the impact of FDI on productivity growth differs across African countries. The heterogeneity is explained by the variation in human capital capacity across these economies. The study reveals a minimum threshold of 6.94 average years of schooling for FDI to accelerate productivity growth in host African countries. The analysis suggests that FDI will raise productivity growth in countries which have attained or exhibited human capital capacity closer to this threshold, when further efforts are applied to enhance such capacity. Countries with human capital capacity far below the threshold, however, will not experience productivity gains from these investments.