Does resource dependence cushion the impact of thin capitalization rules on foreign investment inflows? Evidence from Africa

Abstract

Due both to the prevarication of political elites and to tax evasion and capital flight by multinationals, Africa's development has not benefited as much from the continent's mineral resources as it should have. The thin capitalization rules (TCRs) implemented by several mineral resources rich-countries to alleviate this concern seem contradictory to the attractiveness policies in force, which results in multiple tax cuts, especially when the shocks observed on mineral prices lead to budgetary pressures. This study investigates how changes in mineral prices and rents affect the impact of TCRs on foreign direct investment (FDI) inflows into Africa. The analyzes are carried out through the two-step systems GMM, using data from 33 cross-countries between 2005 and 2018. Consistently with the assembled literature, the study finds that TCRs harm FDI inflows. This study provides an additional contribution by showing a breaking point from which the rise in the price and the rent of minerals becomes a shield that fully absorbs the negative impact of the TCRs on multinationals' decision to settle. The price and the resulting breaking income are such that the negative impact of the TCRs on FDI inflows is overcompensated when, on average for the sample, the mineral price index goes beyond 103.54 or whenever the mineral rent exceeds 28.32% of the host country's GDP. These results are robust when controlling for the efficiency of government in revenue mobilization. The study shows that resource-rich countries in Africa should consider promoting the non-extractive sector's attractiveness in anticipation of the depletion of mineral reserves.