Challenges
of Foreign Investment in Promoting Economic Growth
Group Four
Journal of
International Economics
Volume 45, Issue 1, 1 June 1998, Pages 115-135
Author links open overlay panelE. Borensztein a, J. De
Gregorio b, J-W. Lee c
Abstract
This paper examines the performance,
promotion, and prospects for foreign direct investment (FDI) in Africa. Factors
such as political and macroeconomic instability, low growth,
weak infrastructure, poor governance, inhospitable regulatory environments, and
ill-conceived investment promotion strategies, are identified as responsible
for the poor FDI record of the region. The paper stresses the need for more
trade and investment relations between Africa and Asia. It also argues that
countries in the region should pay more attention to the improvement of
relations with existing investors and offer them incentives to assist in
marketing domestic investment opportunities to potential foreign investors.
Finally, the paper argues that the current wave of globalization sweeping
through the world has intensified the competition for FDI among developing
countries. Consequently, concerted efforts are needed at the national,
regional, and international levels in order to attract significant investment
flows to Africa and improve the prospects for sustained growth and development.
.
Introduction
Forreign Direct Investment (FDI) is considered as one of the
vital ingredients for overall development process of a developing country like
Bangladesh. Industrial development is an important prerequisite for economic
growth of a developing country. Bangladesh is basically a country of agrarian
economy. For her economic development, industrial economy is imperative. So
Bangladesh is gradually moving from agrarian economy to industrial economy. In
the age of globalization, it has become a burning issue to exchange views,
ideas, capital and human resources. Government of Bangladesh is trying to
create a favorable investment environment through introducing economic
policies, incentives for investors, promoting privatization and so on.
Therefore, the contribution of FDI is necessary in the enhancement of a country’s
economic growth. Researchers have marked FDI as an important factor in
accelerating economic success and wealth of a country as well as a door in
creating jobs, facilitating economy, and creating more competitive environment
and contributing productivity to the host country. In Bangladesh, FDI plays a
significant role in GDP acceleration and economic growth (Mottaleb 2007). FDI
has an unmentionable role in the modernization of the Bangladesh economy for
last two decades. It helps the country in building up infrastructure, creating
more employment, developing capacity, enhancing skills of the labor force of
the host country through transferring technological knowledge and managerial
capability, and helping in integrating domestic economy and the global economy.
Various positive attributes of Bangladesh is now drawing the attention of the
investors from both developed and developing countries. In Bangladesh, it iavailable
to get skilled labor at relatively low wages. Moreover, there is reasonably
stable macroeconomic environment. These two important factors can make
Bangladesh an alluring destination for foreign investors. Lowest wage rates
among the Asian countries, tolerable inflation rate, reasonably stable (except
previous year) exchange rate, investment friendly custom regulations and
attractive incentive packages make Bangladesh a favorable investment
destination. Bangladesh became more open toward FDI policies over the last
decades. These above features will certainly maintain the recent advancement in
FDI investment in Bangladesh by the foreign investors. During 1980s, FDI to
Bangladesh was very little and mostly focused in banking and a few other
sectors. Bangladesh started attracting FDI since 1996 in energy and power
sector because of favorable and supportive policies for foreign investment,
economic reform as well as unexplored gas and oil resources. In 1972, annual
FDI inflow was 0.09 million USD and in 1996, it became 231.61 million USD which
rose significantly in 2008 to 1086 million USD which declined to 913.32 million
USD in 2010 (source: Bangladesh Board of Investment).
Regional
After gaining
political independence in the 1960s, African countries––like most developing
nations––were very skeptical about the virtues of free trade and investment.
Consequently, in the 1970s and 1980s several countries in the region imposed
trade restrictions and capital controls as part of a policy of
import-substitution industrialization aimed at protecting domestic industries
and conserving scarce foreign exchange reserves. There is now substantial
evidence that this inward-looking development strategy discouraged trade as
well as foreign direct investment (FDI) and had deleterious effects on economic
growth and living conditions in the region (Rodrik, 1998).
The disappointing
economic performance of African countries beginning in the late 1970s up till
the mid-1990s, coupled with the globalization of activities in the world
economy, has led to a regime shift in favor of outward-looking development
strategies. Since the mid-1990s, there has been a relative improvement in
economic performance in a number of African countries as a result of the change
in policy framework (Fischer, Hernandez-Cata, & Khan, 1998). Available data
for sub-Saharan Africa indicate that the average annual growth rate of real GDP
per capita which was −0.9% over the period 1975–1984 rose to 0.7% in the period
1995–2002 (Fig. 1). But the progress made so far is not enough for sustained
growth and development in the region. Over the past three decades, Africa's
participation in the world economy has declined. The region's share of world
exports fell from 5.9% in 1980 to 2.3% in 2003. Its share of world imports
declined from 4.6 to 2.2% over the same period (Table 1).
Improvements in
economic policies are needed to enhance macroeconomic performance and attain
the minimum growth rate required to meet the Millennium Development Goals set
by the United Nations. An increase in investment is crucial to the attainment
of sustained growth and development in the region. This requires the
mobilization of both domestic and international financial resources. Given the
unpredictability of aid flows, the low share of Africa in world trade, the high
volatility of short-term capital flows, and the low savings rate of African
countries (Fig. 2), the desired increase in investment has to be achieved
through an increase in FDI flows, at least in the short-run.1
Until recently, FDI
was not fully embraced by African leaders as an essential feature of economic
development, reflecting largely fears that it could lead to the loss of
political sovereignty, push domestic firms into bankruptcy due to increased
competition and, if entry is predominantly in the natural resource sector,
accelerate the pace of environmental degradation. Moss et al. (2004) argue that
much of African skepticism toward foreign investment is rooted in history,
ideology, and the politics of the post-independence period. They also argue
that the prevailing attitudes and concerns in the region are due in part to the
fact that policymakers in the region are not convinced that the potential
benefits of FDI could be fully realized in the region. Clearly, the sector in
which a country receives FDI affects the extent to which it could realize its
potential benefits. In East Asia, substantial FDI went into the secondary
sector thereby contributing to the diversification of the export base and to
higher and sustained growth. Africa, on the other hand, receives FDI mostly in
the primary sector, and so the benefits to the region have not been as
significant as in East Asia. In this regard, a key challenge facing Africa is
how to attract more FDI in dynamic products and sectors with high income
elasticities of demand.
Although most of the
concerns of African countries regarding foreign investment are legitimate––for
example, there is some evidence that the activities of foreign oil firms in
Nigeria have had perverse effects on the local environment (EIA,
2003)––experience has shown that if a host country creates an environment
conducive to investment, FDI can play an important role in its development
efforts. Its potential benefits include:
·
•
Employment generation
and growth: By providing additional capital to a host country, FDI can create
new employment opportunities resulting in higher growth. It can also increase
employment indirectly through increased linkages with domestic firms. More
specifically, the location of a foreign firm in a host country generally leads
to the establishment of domestic firms that provide inputs to it thereby
increasing the demand for labor in the economy. Aaron (1999) provides evidence
on the positive impact of FDI on employment in developing countries.
·
•
Supplementing domestic
savings: African countries have low savings rates thereby making it difficult
to finance investment projects needed for accelerated growth and development.
Available data indicate that in sub-Saharan Africa gross domestic savings as a
percentage of GDP fell from 21.3% over the period 1975–1984 to 17.4% in the
period 1995–2002. Furthermore, the gap between domestic savings and investment
was −1.9% of GDP over the period 1975–1984 and −1.0% of GDP during the period
1995–2002 (see Fig. 3). FDI can fill this resource gap between domestic savings
and investment requirements.
·
•
Integration into the
global economy: Openness to FDI enhances international trade thereby
contributing to the integration of the host country into the world economy
(Morrisset, 2000).
·
•
Raising skills of
local manpower: Through training of workers and learning by doing, FDI raises
the skills of local manpower thereby increasing their productivity level. The
idea that FDI enhances the productivity of the labor force is supported by
empirical evidence suggesting that workers in foreign-owned enterprises are
more productive than those in domestic-owned enterprises (Harrison, 1996).
·
•
Transfer of modern
technologies: Foreign firms typically make significant investments in research
and development. Consequently they tend to have superior technology relative to
firms in developing countries. FDI gives developing countries cheap access to
new technologies and skills thereby enhancing local technological capabilities
and their ability to compete on world markets. Blomstrom and Kokko (1998)
provide an interesting survey of the literature on FDI and transfer of
technology.
·
•
Enhanced efficiency:
Opening up an economy to foreign firms increases the degree of competition in
product markets thereby forcing domestic firms to allocate and use resources
more efficiently.
There is a small
literature dealing with issues related to FDI flows to Africa (see for example,
Rogoff & Reinhart, 2003; Akinlo, 2003; Lemi & Asefa, 2003;
Bende-Nabenfe, 2002, Asiedu, 2002a, Asiedu, 2002b; Schoeman, Robinson, &
de-Wet, 2000). However, the existing literature focuses on the empirical
determinants of FDI to the region, with very little discussion of concrete
actions or strategies that could be adopted to promote FDI flows to the region.
The present paper attempts to overcome this limitation. It emphasizes a new
approach to the promotion of investment to the region that is based on
improving relations with existing investors rather than focusing exclusively on
costly activities of Investment Promotion Agencies. Furthermore, it identifies
clearly what needs to be done at the national, regional, and international
level to enhance FDI flows to Africa.
An identification of
responsibilities and actions needed at the national, regional, and
international level is important for two reasons. The first is that
globalization has increased the competition for FDI flows among developing
countries. Since Africa is not one of the preferred destinations for investment
among foreign investors, it is increasingly being recognized that actions by
African countries would have to be complemented by efforts at the regional and
international levels in order to improve the prospects for FDI flows to the
region (CCFA, 2003). Consequently, it is important to identify the
responsibilities that are required at the various levels in order to reverse
Africa's dismal FDI record. Second, the New Partnership for Africa's
Development (NEPAD) and the G8 “Africa Action Plan” call for a new relationship
between African countries and their development partners that is based on
shared responsibility for development effectiveness and outcomes (G8, 2002,
ECA, 2003, World Bank, 2003). One of the areas in which there is clearly a need
for shared responsibility is the attraction of private capital flows to the region.
It is therefore important to identify areas of responsibilities at different
levels to give African policy makers and their development partners concrete
ideas on what they can do to increase FDI flows to the region.
The structure of the
rest of the paper is as follows. Section 2 presents a review of recent FDI
trends while Section 3 deals with Africa's investment and trade relations with
Asia. Section 4 analyzes Africa's FDI performance and potential and Section 5
provides explanations for Africa's poor FDI record. Section 6 outlines and
examines measures to promote FDI flows to Africa, while Section 7 deals with
prospects for FDI flows to the region. The last section contains some
concluding remarks.
Recent trends in FDI
The rapid advances in
technology in the last few decades––especially in transport and
communication––have led to tremendous increases in FDI. Global inward FDI flows
rose from US$ 59 billion in 1982 to a peak of US$ 1491 billion in 2000. On an
annual average basis, FDI inflows increased from 23.1% in the period 1986–1990
to 40.2% over the period 1996–2000. Furthermore, FDI outflows rose from 25.7 to
35.7% within the same period (UNCTAD, 2003).
In 2001, FDI flows
declined for the first time since
Asia, trade and FDI flows to Africa
In terms of sources of
FDI flows to Africa, the United States, France, the United Kingdom, Germany,
and Portugal accounted for most flows to the region from 1996 to 2000. Within
the same period, the United States is the most important source of FDI flows
into the region, accounting for approximately 37% of inflows from developed
countries. This represents a marked-shift from the period 1991–1995 in which
the United Kingdom and France were the most important sources of FDI flows to
the region (
FDI performance and potential
Policymakers are often
interested in the performance of their economy relative to its potential.
Recently, UNCTAD computed two indices for assessing economies in terms of FDI
inflows: the inward FDI performance and potential indices. The inward FDI
performance index is computed as the ratio of a country's share in global FDI
flows to its share in global GDP. For any given country, if the value of the
index is one, this means that the country receives FDI consistent with its relative
size. If
Explaining Africa's poor FDI record
Various explanations
have been adduced for Africa's poor FDI record. In the empirical literature,
the following factors are important determinants of FDI flows to the region.
Promotion of FDI to Africa
One of the development
challenges facing African leaders today is how to attract FDI to the region. A
number of efforts have been made in the past to boost FDI flows to the region
but they have not had any significant impact. These efforts were unsuccessful
because they were ill conceived, did not lift underlying constraints on FDI to
the region, and failed to confront the challenges to the attraction of FDI to
the region posed by the globalization process.
In designing policies
and measures to
Prospects for FDI flows to Africa
Despite the dismal FDI
record of African countries, there is room for optimism because recent
developments in the region in the last few years signal a change in attitude
towards more openness to FDI flows. More specifically, we believe that there
will be modest improvements in FDI flows to the region in the medium to
long-term because of the following:
·
•
FDI policies in Africa
are improving––profit repatriation is now permitted in most countries, tax
incentives are commonplace, there is an
Concluding remarks
FDI can play an
important role in the development efforts of the region. To date, African
countries have not been successful in attracting significant FDI flows,
reflecting largely the combined effects of political and macroeconomic
instability, weak infrastructure, poor governance, inhospitable regulatory
environments, intensification of competition for FDI flows due to
globalization, and poor marketing strategies. There is the need to reverse the
declining FDI trend in the region. This
Acknowledgements
We are grateful to
participants at the Tokyo International Conference on Investment to Africa for
useful discussions. We also thank two anonymous referees of the Journal of
Asian Economics for very insightful comments. As usual, the authors are
responsible for any errors and the views expressed in this paper do not
necessarily represent those of the United Nations Economic Commission for
Africa.
