Foreign direct investment in Africa: the role of natural resources,
market size, government policy, institutions and political instability
Asiedu (2006)
Introduction
when it comes to foreign direct investment (FDI) in Sub-Saharan Africa (SSA), the common
perception is that FDI is largely driven by natural resources and market size. Troubling for 3
reasons:
1. It suggests that FDI in the region is largely determined by an uncontrollable factor, and
that natural resource-poor countries or small countries will attract very little or no FDI,
regardless of the policies the country pursues.
2. The countries in SSA are small in terms of income – 23 out of the 47countries in the
region have a GDP of less than US$3 billion.
3. FDI in resource-rich countries are concentrated in natural resources, and investments in
such industries tend not to generate the positive spillovers (e.g. technological transfers,
employment creation) that are often associated with FDI.
This paper answers 3 questions:
1. What are the determinants of FDI to Africa?
2. Can small countries or countries that lack natural resources attract FDI?
3. How important are natural resources and market size vis-à-vis government policy and
host country’s institutions in directing FDI flows to the region?
This paper contributes to the literature by analyzing the impact of natural resources, market size,
physical infrastructure, human capital, the host country’s investment policies, the reliability of
the host country’s legal system, corruption and political instability on FDI flows.
The main result is that countries that are endowed with natural resources or have large markets
will attract more FDI. However, good infrastructure, an educated labor force, macroeconomic
stability, openness to FDI, an efficient legal system, less corruption and political stability also
promote FDI.
Constraints on FDI to Africa: results from four surveys
Corruption ranks very high in all tables as a constraint. Second, FDI regulations, financing
constraints, weak infrastructure, macroeconomic instability (which includes inflation and
exchange rate risk) and political instability are strong deterrents of FDI to Africa.
Description of the data and the variables
n the FDI literature, the most widely used measure of openness is the share of trade in GDP.
Thus, the positive relationship between trade volumes and FDI implies that countries that wish to
attract more FDI should increase trade. However, as pointed out by Rodriguez and Rodrik
(2000), this type of policy recommendation is not constructive. The reason is that policymakers
do not directly control the volume of trade.
, Institutional variables
For my analysis, I employ two measures of institutional quality: corruption and the extent to
which the rule of law is enforced.
Political risk variables
The hypothesis is that political instability deters FDI. I employ three measures of political
instability: (i) Coups; the number of forced changes in the top government; (ii) Assassinations;
include any politically motivated murder or attempted murder of a high government official; (iii)
Revolutions; include any illegal or forced change in the ruling government.
Other variables
I use the share of minerals and oil in total exports (NATEXP) as a measure of natural resource
availability and GDP to measure the size of the host country’s domestic market. The estimated
coefficients of NATEXP and GDP are expected to be positive.
Conclusion and policy implications
This paper has examined the determinants of FDI to Africa. The results indicate that large local
markets, natural resource endowments, good infrastructure, low inflation, an efficient legal
system and a good investment framework promote FDI. In contrast, corruption and political
instability have the opposite effect. These findings are consistent with the reports of
multinational companies that operate in the region.
The results have several policy implications. First, it suggests that FDI in SSA is not solely
driven by some exogenous factors, and that small countries and/or countries that lack natural
resources can obtain FDI by improving their institutions and policy environment. Second,
multilateral organisations such as the IMF and the World Bank can play an important role in
facilitating FDI by promoting good institutions in countries in SSA.
Regional economic cooperation may enhance FDI:
1. Regionalism can promote political stability by restricting membership to democratically
elected governments.
2. Regionalism permits countries to coordinate their policies. For example, members of a
regional bloc may require all participating countries to curb corruption, implement sound
and stable macroeconomic policies, and adopt an ‘investor-friendly’ regulatory
framework.
3. Another advantage of regionalism is that it expands the size of the market, and therefore
makes the region more attractive for FDI.
Finally, it is important to note that increased FDI does not necessarily imply higher economic
growth. Indeed, the empirical relationship between FDI and growth is unclear.
Is good governance rewarded? A cross-national analysis of debt
forgiveness
market size, government policy, institutions and political instability
Asiedu (2006)
Introduction
when it comes to foreign direct investment (FDI) in Sub-Saharan Africa (SSA), the common
perception is that FDI is largely driven by natural resources and market size. Troubling for 3
reasons:
1. It suggests that FDI in the region is largely determined by an uncontrollable factor, and
that natural resource-poor countries or small countries will attract very little or no FDI,
regardless of the policies the country pursues.
2. The countries in SSA are small in terms of income – 23 out of the 47countries in the
region have a GDP of less than US$3 billion.
3. FDI in resource-rich countries are concentrated in natural resources, and investments in
such industries tend not to generate the positive spillovers (e.g. technological transfers,
employment creation) that are often associated with FDI.
This paper answers 3 questions:
1. What are the determinants of FDI to Africa?
2. Can small countries or countries that lack natural resources attract FDI?
3. How important are natural resources and market size vis-à-vis government policy and
host country’s institutions in directing FDI flows to the region?
This paper contributes to the literature by analyzing the impact of natural resources, market size,
physical infrastructure, human capital, the host country’s investment policies, the reliability of
the host country’s legal system, corruption and political instability on FDI flows.
The main result is that countries that are endowed with natural resources or have large markets
will attract more FDI. However, good infrastructure, an educated labor force, macroeconomic
stability, openness to FDI, an efficient legal system, less corruption and political stability also
promote FDI.
Constraints on FDI to Africa: results from four surveys
Corruption ranks very high in all tables as a constraint. Second, FDI regulations, financing
constraints, weak infrastructure, macroeconomic instability (which includes inflation and
exchange rate risk) and political instability are strong deterrents of FDI to Africa.
Description of the data and the variables
n the FDI literature, the most widely used measure of openness is the share of trade in GDP.
Thus, the positive relationship between trade volumes and FDI implies that countries that wish to
attract more FDI should increase trade. However, as pointed out by Rodriguez and Rodrik
(2000), this type of policy recommendation is not constructive. The reason is that policymakers
do not directly control the volume of trade.
, Institutional variables
For my analysis, I employ two measures of institutional quality: corruption and the extent to
which the rule of law is enforced.
Political risk variables
The hypothesis is that political instability deters FDI. I employ three measures of political
instability: (i) Coups; the number of forced changes in the top government; (ii) Assassinations;
include any politically motivated murder or attempted murder of a high government official; (iii)
Revolutions; include any illegal or forced change in the ruling government.
Other variables
I use the share of minerals and oil in total exports (NATEXP) as a measure of natural resource
availability and GDP to measure the size of the host country’s domestic market. The estimated
coefficients of NATEXP and GDP are expected to be positive.
Conclusion and policy implications
This paper has examined the determinants of FDI to Africa. The results indicate that large local
markets, natural resource endowments, good infrastructure, low inflation, an efficient legal
system and a good investment framework promote FDI. In contrast, corruption and political
instability have the opposite effect. These findings are consistent with the reports of
multinational companies that operate in the region.
The results have several policy implications. First, it suggests that FDI in SSA is not solely
driven by some exogenous factors, and that small countries and/or countries that lack natural
resources can obtain FDI by improving their institutions and policy environment. Second,
multilateral organisations such as the IMF and the World Bank can play an important role in
facilitating FDI by promoting good institutions in countries in SSA.
Regional economic cooperation may enhance FDI:
1. Regionalism can promote political stability by restricting membership to democratically
elected governments.
2. Regionalism permits countries to coordinate their policies. For example, members of a
regional bloc may require all participating countries to curb corruption, implement sound
and stable macroeconomic policies, and adopt an ‘investor-friendly’ regulatory
framework.
3. Another advantage of regionalism is that it expands the size of the market, and therefore
makes the region more attractive for FDI.
Finally, it is important to note that increased FDI does not necessarily imply higher economic
growth. Indeed, the empirical relationship between FDI and growth is unclear.
Is good governance rewarded? A cross-national analysis of debt
forgiveness
