Determinants of FDI in Cape Verde: Empirical Evidence for the Period 1986-2019

Abstract

Cape Verde has attracted high Foreign Direct Investment (FDI) flows in the last 15 years. Although there is growing literature on the determinants of FDI in developing countries, only a few studies are available addressing African countries. This paper aims to fill this gap and identify the main economic and political determinants of FDI in Cape Verde, a small African country. The analysis is based on data from 1986 to 2019 concerning several macroeconomic and political variables that are potential determinants of Cape Verde's FDI inflows. Firstly, several unit root tests are run, such as the Augmented Dickey-Fuller, Dickey-Fuller-GLS, Phillips-Perron and KPSS tests. As the time series are generally integrated, they are tested for cointegration using Johansen's maximum-eigenvalue and trace tests. Then, a vector error correction model (VECM) is fitted to the data and its goodness-of-fit is satisfactory, enabling the estimation of a long-run regression equation for the FDI, our primary purpose. The fitted model concludes that market growth, macroeconomic instability, infrastructures, political stability, and trade openness are important determinants of FDI inflows. As expected, all but macroeconomic instability have a positive impact on FDI, which means that: economic growth attracts FDI; macroeconomic instability deters FDI; a country with good infrastructure quality can attract larger FDI inflows; a country's political stability brings larger FDI inflows; trade openness also induces FDI, and its impact is quite strong. Furthermore, the estimate of FDI's speed of adjustment or error correction towards the equilibrium is 0.16 percentage points. Maximizing the benefits of FDI requires policymakers to implement appropriate domestic policies. Thus, the above determinants have to be regarded as crucial competitiveness tools for Cape Verde's success as an FDI host country, namely boosting economic growth and ensuring its sustainability, keeping price (macroeconomic) stability, investing in building infrastructures and developing Information and Communication Technologies, ensuring political stability and good government practices, and implementing reforms towards a more export-oriented trade regime.