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World Journal of Entrepreneurship, Management and Sustainable
Development
Emerald Article: The impact of governance on FDI flows to African countries
Yagoub Ali Gangi, Rafid S. Abdulrazak
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Yagoub Ali Gangi, Rafid S. Abdulrazak, "The impact of governance on FDI flows to African countries", World Journal of
Entrepreneurship, Management and Sustainable Development, Vol. 8 Iss: 2 pp. 162 - 169
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The impact of governance on FDI
flows to African countries
Yagoub Ali Gangi and Rafid S. Abdulrazak
Ahmed bin Mohammad Military College, Doha, Qatar
Abstract
Purpose – The purpose of this paper is to investigate the effect of governance indicators (political
stability, control of corruption, rule of law, regularity quality, voice and accountability and government
effectiveness) on foreign direct investment (FDI) flows to African countries.
Design/methodology/approach – The authors employed a panel regression model on data from
50 African countries for the period 1996 to 2010. The empirical analysis uses the fixed and
random effects estimation.
Findings – The results obtained through fixed and random effects indicate that out of the six
World Bank’s governance indicators, three are statistically significant. These are voice and
accountability, government effectiveness and rule of law. This result implies that to improve their
investment climate and increase the inflow of FDI, African countries need to improve the state of
governance.
Research limitations/implications – The major limitation of this paper is the absence of different
sources for governance indicators, and absence of long time series data on some other governance
indicators such as transparency.
Originality/value – These results lead to the conclusion that some governance indicators are
very important for foreign investors in their investment decisions, while other indicators are not.
Governments have to consider these indicators while trying to attract foreign investment.
Keywords Africa, International investments, Governance, African countries,
Foreign direct investment, Capital flows, Panel data regression
Paper type Research paper
1. Introduction
The experiences of different countries with foreign direct investment (FDI) have let
people recognize that it can benefit the recipient countries through different ways.
It can help in bridging the gap in domestic saving, contributing with foreign exchange
for balance of payments, improving the production technology through the so-called
technology transfer process, enhancing managerial practices through competition and
labor mobility and promote economic growth through capital accumulation (Mottaleb
and Kalirajan, 2010; Crespo and Fontoura, 2007). There is no doubt that governments
of different African countries recognize the importance of FDI for their economies and
the benefits that it may bring for their nations. This recognition is directly reflected
into economic policies adopted by these countries recently. If not all, at least most of the
African countries have revised their economic policies in order to improve their
investment climate and promote their economies to attract more investment. In this
context, African countries have opened their economies and have allowed the entry of
multinational corporations as part of economic reform which was initiated and
supported by the World Bank and the IMF in the early 1990s. In line with this, African
countries have offered great incentives which include huge tax exemptions for foreign
investments in many important sectors, accompanied by generous incentive packages
for foreign investors. In spite of all these efforts, the outcome in terms of FDI inflow to
African countries has been disappointing.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/2042-5961.htm
World Journal of Entrepreneurship,
Management and Sustainable
Development
Vol. 8 No. 2/3, 2012
pp. 162-169
rEmerald Group Publishing Limited
2042-5961
DOI 10.1108/20425961211247761
162
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8,2/3
While the amount of FDI flow to the African countries has increased in absolute
terms during the past two decades, it has declined in relative term (Onyeiwu and
Shrestha, 2004).
One of the possible justifications for African countries failure in attracting sufficient
amount of FDI is that the economic reforms have not been accompanied by political
and institutional reforms that could help in creating effective institutions and improve
African state of governance. Ngowi (2001) argues that Africa has received little
FDI because most countries are regarded by foreign investors as high risk and are
characterized by a lack of political and institutional stability and predictability.
Moreover, it has been generally argued that foreign investors and multinational
corporations believe that good governance in the host country is very important for
choosing investment locations and deciding the investment amount. Because good
governance is a safeguard for their invested capital, that reduce political and economic
risks. Contrary to political instability and poor governance that may hinder economic
development, increase the country’s risk and hence disturb the flow of FDI plan to both
private and public sectors (Samimi et al., 2011).
This paper concentrates on the relationship between six governance indicators
(political stability, control of corruption, rule of law, regularity quality, voice and
accountability and government effectiveness) and FDI flows to African countries. It
tries to identify the causal relationship between governance indicators and FDI flow.
By so doing, the paper will provide an answer based on empirical results for the
question “Does state of governance in hosting countries matter for foreign investors?”
How can social, economic and political governance (such as regularity quality, absence
of violence, effectiveness of government, control of corruption, rule of law) serve
foreign investor’s needs? Questions like these have created need for this kind of work to
be carried out. A panel regression analysis technique is used to investigate the impact
of the six governance indicators on FDI flows. Fixed- and random-effects models are
adopted to explore whether the governance indicators affect FDI flows to Africa in
conventional ways. Panel data for about 50 African countries over the period 1999-2010
are used to estimate the model.
This paper contains five sections. Section 2 presents literature review that
concentrate on the empirical studies investigated the determinants of FDI. Section 3
discusses state of governance in African countries. Section 4 outlines the flow of FDI to
African countries with emphasis on trend and distribution among different countries.
Section 5 presents the empirical model. The conclusion drawn from the analysis is
presented in the last section.
2. Literature review
Recognizing that FDI as a key factor for economic growth and important tool for
bringing technology to recipient countries, it has received great attention from many
economists in recent literature. The literature on FDI can be categorized into three
main groups: the first group investigates the effect of FDI on macroeconomic
indicators, such as economic growth, exchange rate, rates of inflation, balance of
payments and rates of unemployment. The second group examines the impact of FDI
on different factors such as technology transfer to recipient countries, management
practices by national firm and labor skill and productivities in hosting countries. The
third group focusses on the determinants of FDI and the main driving forces for its
inflow and outflows to different countries. This topic remains a hot issue for
researchers from different disciplines for a long period of time. Their main concern has
163
FDI flows to
African countries
been to identify the key variables that cause variation in FDI and hence can be used
as instruments for economic policies conducive for FDI attractiveness. This group
can be subdivided into two sub-groups: the first sub-group undertaken at country
level using time-series data. In these studies determinants of FDI were examined
for individual countries over specific period of time. The variables identified by
these studies include, GDP growth, GDP level, degree of openness measured
by balance of trade, real exchange rate, political stability, market size measured by per
capita income and size of population, domestic investment, the return or cost of capital
rate as variable reflecting the costs of production in the host countries. The second sub-
group undertaken across a set of country level over specific period of time using panel data
an example of which includes Onyeiwu and Shrestha (2004), Samimi and Ariani (2010).
In the literature there were no studies that examined the relation between governance
and FDI flows to countries. However, the impacts of some of the good governance
indicators on FDI flows were examined as part of the determinants of FDI. Because of
that, our review of the literature concentrated on the empirical studies that were related to
the determinants of FDI. This can help identify the main factors that cause variation in
FDI flows to different countries and at the same time investigate the relation between
good governance indicators and FDI flows. Samimi and Ariani (2010) use annual
aggregate data for 16 countries in MENA region covering the period (2002-2007) to
investigate the impact of good governance on FDI. They found that control of corruption
and political stability as indicators for governance are statistically significant variables
which positively affected FDI flows to countries of MENA region. Onyeiwu and Shrestha
(2004) use the fixed- and random-effect models based on a panel dataset for 29 African
countries over the period (1975-1999) to explore whether the stylized determinant of
FDI, affect FDI flows to Africa in conventional ways. They found that economic
growth, inflation, openness of the economy, international reserves and natural resource
availability are the main significant factors for FDI flows to Africa. While political rights
and infrastructures were found to be unimportant for FDI flows to Africa. Asiedu (2002)
examined whether the factors that affect FDI in developing countries also affect FDI flows
to Sub-Saharan African (SSA) countries. She used cross-section data for 71 developing
countries and found that some variables that are significant for FDI flows to developing
countries do not seem to be important for FDI flows to SSA. These include the rate of
return on investment and better infrastructure.
3. State of governance in African countries
There are many definitions, types and indicators of governance in the literature. The
detail discussion and explanations of these types and definitions is beyond the scope of
this paper. We limit our self to the World Bank definition for governance as “the ways
public officials and public institutions acquire and exercise authority to provide public
goods and services, including basic services, infrastructure, and a sound investment
climate.” The state of governance at regional or global level is assessed and compared
through what so-called governance indicators. A number of different indicators are in
use by different institutions. For the purpose of this paper, the World Bank’s worldwide
governance indicators (WGT) are used as measurement for the quality of governance.
In this measurement, countries are ranked with respect to six aspects of good
governance: voice and accountability (VA), political stability and absence of violence
(PSAV), government effectiveness (GE), rule of law (RL), regulatory quality (RQ) and
control of corruption (CC). The performance of a country in each one of the six aspects
is reflected with an index ranges from 2.5 (weak) to 2.5 (strong).
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Table I shows indexes for the estimates of the six governance indicators for
53 African countries. As clearly seen that the performances of most of the African
countries are very weak as reflected with a large index estimate for all six indicators.
With exception of Botswana, Mauritius and Namibia all the rest of the African
countries have at least one of the six governance indicators is negative. The second
best group that has one negative index of estimate for governance indicators contains
South Africa, Cape Verde and Seychelles. Tunisia stood alone in one group which has
only negative index estimate in two governance indicators. The rest of the countries
have negative index estimate for all or at least four governance indicators. In the next
section FDI flow to Africa are examined in order to get some idea about, its size, trend
and distribution among different countries.
4. FDI flows to Africa: trend and distribution
The FDI flow worldwide has increased rapidly throughout the last two decades, and
African countries have benefited from this boom. The actual inflows of FDI into all
53 African countries have steadily increased from about $5 billion in early 1990s to
about $20 billion in late 1990s. This reflects an annual average growth rate of about
18 percent for this period, compared with a global average growth rate of 20 percent.
FDI flows to African countries have maintained their uprising trend during the 2000s
and have increased from about $35 billion in early 2000s to about $73 billion in 2008.
Nevertheless, FDI flows to African countries have registered a declining trend during
the years 2009 and 2010 because of the international financial crises. The FDI flow
declined to $60.2 billion in 2009 and stood at about $55billion in 2010 (United Nations
Conference on Trade and Development (UNCTAD), 2010). These conclusions can be
seen from Figure 1.
In terms of distribution among different countries FDI has taken place all over
African countries, but the largest proportion appears to be located in a limited number
of countries. The countries that have succeeded to attract the largest portion of FDI to
Africa are Angola, Nigeria, Egypt and South Africa. These four countries accounted
for about 53 percent of the total amount of FDI flows to Africa during the period 1990-
2010. Contrary some countries have failed to attract reasonable amount of FDI flows, a
set of 27 African countries have received o5 percent of the total FDI flows to Africa
during the period 1990-2010 which was excluded from Figure 2. The figure portrayed
the distribution of the FDI among the top 29 receiving countries.
5. Empirical model
To estimate the relationship between the six governance indicators and FDI flows
to Africa, a panel regression model for 50 African countries for the period 1996-2010
is employed. Since most of the explanatory variables have negative values we cannot
use the logs. Therefore the model is assumed to be linear and taking the following
form:
FDIit ¼b0þb1VAit þb2PSAVit þb3GEit þb4RQit þb5RLit þb6CCit þmit ð1Þ
where FDI
it
, percentage of FDI flows to GDP in country iand in year t;VA
it
,voiceand
accountability index in country iand year t;PSAV
it
, political stability and absence of
violence index estimate in country iand year t;GE
it
, government effectiveness index in
country iand in year t;RQ
it
, regulatory quality in country iand in year t;RL
it
,ruleoflaw
index in country iand in year t;CC
it
, control of corruption index in country iand in year t.
165
FDI flows to
African countries
The governance indicators
Country VA PSAV GE RQ RL CC
Algeria 1.043 1.441 0.665 0.712 0.789 0.635
Angola 1.284 1.106 1.203 1.301 1.447 1.308
Benin 0.239 0.511 0.433 0.399 0.474 0.650
Botswana 0.593 0.923 0.549 0.610 0.605 0.886
Burkina Faso 0.392 0.031 0.670 0.252 0.488 0.185
Burundi 1.110 1.905 1.320 1.300 1.282 1.066
Cameroon 1.053 0.562 0.818 0.804 1.175 1.019
Cape Verde 0.713 0.917 0.130 0.203 0.500 0.440
Central African Republic 0.987 1.609 1.461 1.117 1.469 1.081
Chad 1.230 1.550 1.165 1.040 1.263 1.186
Comoros 0.510 0.255 1.569 1.409 1.057 0.861
Congo 1.133 1.012 1.260 1.209 1.300 1.044
Cote d’lvoire 1.150 1.552 0.993 0.738 1.307 0.887
Congo, Democratic Republic 1.585 2.338 1.715 1.634 1.727 1.478
Djibouti 0.936 0.284 0.897 0.751 0.736 0.563
Egypt 1.036 0.590 0.353 0.328 0.027 0.465
Equatorial Guinea 1.728 0.079 1.494 1.444 1.289 1.480
Eritrea 1.853 0.844 1.132 1.645 0.790 0.036
Ethiopia 1.144 1.447 0.729 1.054 0.747 0.715
Gabon 0.722 0.214 0.685 0.316 0.458 0.773
Gambia 0.897 0.248 0.603 0.454 0.204 0.570
Ghana 0.180 0.072 0.101 0.154 0.103 0.121
Guinea 1.247 1.534 1.039 0.980 1.341 0.894
Guinea-Bissau 0.839 0.753 1.214 1.085 1.415 1.065
Kenya 0.386 1.168 0.576 0.266 0.940 0.951
Lesotho 0.209 0.042 0.325 0.546 0.133 0.113
Liberia 0.799 1.581 1.498 1.577 1.503 1.005
Libya 1.787 0.045 1.048 1.432 0.857 0.930
Madagascar 0.206 0.122 0.588 0.443 0.444 0.100
Malawi 0.309 0.077 0.537 0.412 0.294 0.512
Mali 0.174 0.192 0.823 0.394 0.346 0.504
Mauritania 0.864 0.206 0.484 0.398 0.621 0.323
Mauritius 0.846 0.837 0.592 0.543 0.935 0.522
Morocco 0.636 0.378 0.115 0.174 0.029 0.137
Mozambique 0.103 0.163 0.454 0.428 0.672 0.478
Namibia 0.361 0.572 0.140 0.195 0.205 0.303
Niger 0.551 0.450 0.878 0.608 0.742 0.867
Nigeria 0.846 1.640 0.983 0.943 1.263 1.102
Rwanda 1.359 1.080 0.557 0.742 0.868 0.345
Sao Tome and Principe 0.247 0.541 0.650 0.764 0.448 0.450
Senegal 0.004 0.368 0.231 0.231 0.186 0.270
Seychelles 0.043 0.855 0.120 0.558 0.273 0.309
Sierra Leone 0.596 0.845 1.294 1.128 1.154 0.896
Somalia 1.883 2.703 2.174 2.439 2.344 1.738
South Africa 0.660 0.183 0.616 0.530 0.100 0.401
Sudan 1.687 2.265 1.226 1.326 1.436 1.218
Swaziland 1.323 0.079 0.774 0.505 0.707 0.273
Togo 1.190 0.448 1.363 0.751 0.864 0.871
Tunisia 1.009 0.139 0.459 0.009 0.064 0.014
Uganda 0.668 1.306 0.540 0.049 0.535 0.817
Tanzania 0.325 0.439 0.458 0.418 0.374 0.652
Zambia 0.360 0.139 0.835 0.489 0.523 0.736
Zimbabwe 1.367 1.137 1.023 1.811 1.490 1.159
Source: World Bank (2010)
Tabl e I.
Averages (for years
1966, 1998, 2000 and
2003-2010) of the six
governance indicators
for African countries
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WJEMSD
8,2/3
Different data sources are used in this paper. FDI flows measured in million of US
dollars is obtained from the database of the UNCTAD. Data for governance six
indicators’ index is obtained from the World Bank’s WGT.
The estimation of the model for random and fixed effect produces the results in Table II.
The results in Table II shows that voice and accountability, government effectiveness
and rule of law are statistically significant variables that affect FDI flow to African
countries. These factors have positive impact on FDI flows to African countries. While the
FDI flow (millions US$)
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
80,000
70,000
60,000
50,000
30,000
40,000
20,000
10,000
0
Year
Source: United Nations Conference on Trade and Development (2010)
Figure 1.
FDI flow (millions US$)
sum of years 1990-2010
for African countries
Stock of FDI (millions US$)
Country
Source: United Nations Conference on Trade and Development (2010)
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
Angola
Nigeria
Egypt
South Africa
Morocco
Sudan
Tunisia
Libyan Arab Jamahiriya
Algeria
Congo
Ghana
Democratic Republic of the Congo
Zambia
Equatorial Guinea
United Republic of Tazan
Uganda
Namibia
Cote d’lvoire
Mozambique
Madagascar
Botswana
Ethiopia
Chad
Cameroon
Niger
Liberia
Mauritius
Senegal
Mauritania
Figure 2.
Stock of FDI (millions
US$) for African countries
for the years 1990-2010
167
FDI flows to
African countries
other three governance indicators (i.e. political stability, regulatory quality and control of
corruption) are insignificant. The three significant variables explain about 63 percent of
the variation of FDI flows to African countries. When comparing these results with
results of previous studies different points can be observed. None of the three significant
factors were included as part of explanatory variables of previous studies. While two of
the three insignificant factors (political stability and control of corruption) were found as
positively impacted on FDI flows to countries.
6. Conclusion
This paper investigated from an empirical point of view, the impact of governance on
FDI flows to African countries. The results indicate that voice and accountability,
government effectiveness and the rule of law, as measurements for governance, have a
positive impact on FDI flows to African countries. While political stability, regulatory
quality and control of corruption, as other indicators for governance, have no real
impact on FDI flows to Africa. Thus, we can conclude that beside economic reforms
African countries need to adopt institutional reforms that could contribute in
improving their state of governance, promote their investment climate and help in
attracting more FDI.
References
Asiedu, E. (2002), “On the determinants of foreign direct investment to developing countries: is
Africa different?”, World Development, Vol. 30 No. 1, pp. 107-19.
Crespo, N. and Fontoura, M.P. (2007), “Determinants factors of FDI spillovers – what we really
know?”, World Development, Vol. 35 No. 3, pp. 410-25.
Mottaleb, A.K. and Kalirajan, K. (2010), “Deter minants of foreign direct investment in developing
countries: a comparative analysis”, Margin: The Journal of Applied Economic Research,
Vol. 4 No. 4, pp. 369-404.
Ngowi, H.P. (2001), “Can Africa increase its global share of foreign direct investment (FDI)?”,
West African Review, Vol. 2 No. 2, pp. 1-22.
Dependent variable: FDI flows
Effects: Country fixed; years fixed
Model parameters Coefficient estimate t-statistic p-value
Constant
C 938.9750 0.0000
Independent variables coefficients
VA 665.4306 0.0062
PSAV 481.7628 0.1110
GE 372.0113 0.0032
RQ 185.1446 0.5529
RL 1,350.637 0.0000
CC 381.5822 0.0695
R
2
0.673961
Adjusted R
2
0.634214
F-statistic (p-value) 16.95637 (0.0000)
Durbin-Watson 0.759381
Hausman statistic (p-value)
Years 21.341820 (0.0016)
States 14.639213 (0.0233)
Table II.
Two ways effects panel
regression analysis results
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Onyeiwu, S. and Shrestha, H. (2004), “Determinants of foreign direct investment in Africa”,
Journal of Developing Societies, Vol. 20 Nos 1-2, pp. 89-106.
Samimi, J.A. and Ariani, F. (2010), “Governance and FDI in MENA region”, Australian Journal of
Basic and Applied Sciences, Vol. 4 No. 10, pp. 4880-2.
Samimi, J.A., Monfared, M., Moghaddasi, R. and Azizi, K. (2011), “Political stability and FDI in
OIC countries”, Journal of Social and Development Sciences, Vol. 1 No. 1.
United Nations Conference on Trade and Development (UNCTAD) (2010), “Inward and outward
foreign direct investment stock, annual, 1980-2010”, available at: http://stats.unctad.org/
fdi/reportfolder (accessed January 19, 2012).
World Bank (2010), “Governors indicators”, World Resource Institute, available at: www.wri.org
(accessed October 31, 2011).
Further reading
Athukorala, P.-C. (2009), “Trends and patterns of foreign direct investment in Asia: a comparative
perspective”, The Journal of Applied Economic Research, Vol. 3 No. 4, pp. 365-408.
Campos, F.N. and Nurgent, B.J. (2003), “Aggregate investment and political instability: an
econometric investigation”, Economica, Vol. 70, pp. 533-49.
Chan, K.K. and Gemayel, E.R. (2004), “Risk instability and the pattern of foreign direct
investment in the Middle East and North Africa”, Working Paper No. WP/04/39, IMF,
Washington, DC.
Kaufmann, D. and Massimo, M. (2010), “The worldwide governance indicators: methodology
and analytical issues”, The World Bank’s Policy Research Working Paper No. 5430,
Washington, DC.
Kim, H. (2010), “Political stability and foreign direct investment”, International Journal of
Economics and Finance, Vol. 2 No. 3, pp. 59-71.
Corresponding author
Yagoub Ali Gangi can be contacted at: yagoubgangi@hotmail.com
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FDI flows to
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