FDI-GROWTH NEXUS IN AFRICA: DOES GOVERNANCE MATTER?

Abstract

This study examined the effects of governance on FDI-growth nexus in Africa both at the aggregated and disaggregated level. It adopted the methodology of panel data technique to examine the interrelationship. The results showed that governance in many African countries was quite weak and thus inhibited growth. When governance was interacted with FDI, it brought about positive and increased growth. This finding was robust to different estimation techniques and disaggregated governance dimensions. The paper suggested that African governments that are desirous of attracting more FDI and thus improving on growth must enhance their governance structure.Keywords: Foreign Direct Investment, Growth, Governance, Panel Data, AfricaJEL classification: C33, F21, O551. INTRODUCTIONThe role of Foreign Direct Investment (FDI) as a source of capital has become increasingly important to many emerging countries in the world and Sub-Saharan Africa (SSA) countries in particular. FDI inflow has been critical because of its potential and actual benefits to growth, employment generation, technological know-how, enhanced efficiency and competitiveness, supplements to domestic savings and integration into the global economy (Asiedu, 2002). In the developing world, FDI has become the most stable and largest component of capital flows. Consequently, FDI has become an important alternative in the development finance process (Global Development Finance, 2005; Adams, 2009ab Mengistu and Adams, 2007).Though many researchers allude to the importance of FDI in the move towards economic growth, in recent times, the discussion has basically moved from whether developing countries should attract FDI, to how developing countries can attract FDI (Asiedu and Lien, 2011). In the light of this, many SSA countries have undertaken several policies that are aimed at attracting FDI. For instance, many have initiated economic reforms that are aimed at increasing the roles of the private sector through privatising state-owned enterprises, they have sought to restore and maintain macroeconomic stability through devaluation of overvalued national currencies and reduction of inflation rates and budget deficits. They have equally improved the regulatory framework for FDI by strengthening the rule of law, engaging in trade liberalization, and improving legal institutions, telecommunications and transportation infrastructure amongst others (UNCTAD, 1999). However, despite these reforms, SSA has not experienced the dramatic impact of increase in FDI on its growth as experienced in other parts of the developing world (Asiedu, 2005).Indeed the empirical evidence to date on the effects of FDI on economic performance is not definite. Some studies indicate a positive impact of FDI on economic growth (Ghura and Hadjimichael, 1996; Bengoa and Sanchez-Robles, 2003; among others) while other studies report otherwise (Carkovic and Levine, 2002; Durham, 2004). On the other hand, some other group of studies suggest that the effect of FDI on a host country's economy is dependent on certain factors such as the country's absorptive capacity in terms of its human capacity, the country's the level of development, (Borensztein et al., 1998; Mengistu and Adams, 2007), its sectoral pattern (Dutt, 1997) and its financial development (Alfaro, et al., 2006). These studies seem to suggest that for countries in SSA, to reap the benefits that ensue from FDI, if any, may be more difficult than attracting FDI because the policies that promote FDI to SSA also have a direct impact on its long-term economic growth (Asiedu, 2005). …