Abstract
PurposeThis paper investigates whether democracy plays a mediating role in the relationship between foreign direct investment (FDI) and inequality in Sub-Saharan Africa (SSA).Design/methodology/approachThe empirical analysis is conducted using fixed effects and system GMM (Generalised Method of Moments) on a panel of 38 Sub-Saharan African countries covering the period of 1990–2018.FindingsThe results find that FDI has no direct effect on inequality whereas democracy reduces inequality directly in both the short run and the long run. The sensitivity analyses find that democracy improves equality regardless of the magnitude of FDI, resource endowment or democratic deepening whereas FDI only reduces inequality once a moderate level of democracy has been achieved.Social implicationsThe results discussed above thus have four policy implications. First, these results show that although democracy has inequality reducing benefits, SSA is unlikely to significantly reduce inequality unless the region purposefully diversifies its trade and FDI away from natural resources. Second, the region should continue to expand credit access to reduce inequality and attract FDI. Third, policymakers should undertake reforms that will reduce youth inequality. Lastly, the region should focus on long-run democratic reforms rather than on short-run democratization to improve governance and investor confidence.Originality/valueAlthough there are existing studies that examine the association between FDI and inequality, FDI and democracy and democracy and inequality, this is the first study to explicitly examine the effect of democracy on the association between FDI and inequality in SSA, and the first study to separately consider the possible varied effects of contemporaneous democratization versus the long-run accumulation of democratic capital. In addition, rather than measure inequality by income alone, this study uses the more appropriate Human Development Index to account for SSA's sociological, education and income disparities.
Highlights
Over the last quarter century, foreign direct investment (FDI) to Sub-Saharan Africa (SSA) increased from $1.2bn in 1990 to $31bn in 2018 (World Bank, World Bank Development Indicators (WDI) Data) while the average Polity V democracy index improved from À5 to 3
Yi;t 1⁄4 Yi;t−1 þ βDi;t þ δXi;t þ εi;t where Yi;t denotes inequality for country i at time t; Di represents the three factors of interest comprising net FDI inflows as a percentage of gross domestic product (GDP), and the two democracy factors – contemporaneous democracy (Demo) and the accumulation of democratic capital (Demo_Cap); Xi is a vector of six macroeconomic control factors comprising economic growth (GDPG), trade openness (Trade), credit extension (Credit), inflation (Inf), fixed investment (GFCF) and youth population (Pop_U14); μi is the time-invariant country effect; μt is the common time effect and εi;t is the error term
This section discusses the results of the fixed effects and system GMM analyses of the relationship between democracy, FDI and inequality in 38 SSA countries over the period of 1990–2018
Summary
Over the last quarter century, foreign direct investment (FDI) to Sub-Saharan Africa (SSA) increased from $1.2bn in 1990 to $31bn in 2018 (World Bank, WDI Data) while the average Polity V democracy index improved from À5 to 3. Dependency Theory counters that the reliance on FDI for economic development tends to create an elite pool of labour in international sectors with wages significantly above those in domestic sectors This hampers efforts to improve broader redistribution (Evans, 1979), and tends to foster capital intensive rather than labour intensive development, which, over time, leads to higher unemployment and inequality (Reuveny and Li, 2003; Milanovic, 2005; Choi, 2006; Herzer and Nunnenkamp, 2011). Gossel (2017) further shows that FDI is affected by the long-run accumulation of democratic capital to a greater extent than by short-run democratic reforms or by the components of democracy (civil liberties and political rights) and Kunawotor et al (2020) find that only the control of corruption and the rule of law reduce inequality while the other common measures of institutional quality are insignificant. The HDI is interpreted as the opposite of the GINI index since the lower the HDI score, the worse the level of inequality
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