Foreign Aid, Foreign Direct Investment and Governance in Africa

Abstract

In Africa, good governance has been preached as a panacea to reverse economic plight, to attract inflow of capital, and, in some cases, to reverse capital outflows. The flow of capital, however, has side effects on host economies' governance, among other things. Given the highly expected economic impacts, it has also becoming clear that the increased inflow of Foreign Direct Investment (FDI) and Official Development Aid (ODA) may have impacts on governance institutions of a host country. But the direction of the impact is not obvious. Knack and Rehman (2007) as well as Brautigam and Knack (2004) report negative association between foreign aid and governance indicators whereas Goldsmith (2001) indicates positive relationship between the two variable in Sub-Saharan Africa. Using data on governance indicators, FDI and ODA, the present study explores further whether FDI and ODA promote good governance in Africa during 1975-2002 to explain these conflicting results. The results of the study confirm that ODA has had positive and significant effects on governance, whereas for the case of FDI, although contemporaneous effects could not be detected, significant effects from FDI come only a year or two after FDI firms commit themselves to start actual operation in a host country.