# 24. Does Market Size Explain Foreign Direct Investment Flows to Sub-Sahara Africa?

Extended Abstract by

William A. Amponsah and Pablo Garcia Fuentes.

Economic activity has been quite robust recently in Sub-Saharan Africa (SSA).  Supported by strong domestic demand, GDP growth in the region grew to 4.7 percent in 2013 from the rate of 3.5 percent in 2012.  In fact, excluding South Africa that experienced a slower growth rate of 1.9 percent, growth in the rest of the SSA region was 6.1 percent (World Bank, 2014).  That has marked the region recently as one of the fastest-growing in the world, buoyed by strong investment demand and robust private consumption. 

Global foreign direct investment (FDI) inflows were projected to reach from $1.4 trillion to 1.6 trillion in 2011 building upon a modest recovery but below the 2007 pre-financial crisis peak of $2 trillion (UNCTAD, 2011).  Developing and transition economies attracted half of global FDI flows in 2009, and have continued to be favorable destinations for FDI to date.  FDI inflows into the whole African continent doubled from $9 billion in 2000 to $18 billion in 2004 and then to the peak of $88 billion in 2008 amidst the resource boom of that period (UNCTAD, 2009).  Of the 2008 peak FDI net inflows of $88 billion destined for Africa, West Africa attracted $27 billion, Southern Africa attracted $27 billion, Central Africa attracted $4 billion, East Africa attracted $6 billion and North Africa attracted $24 billion (UNCTAD, 2010).  Therefore, SSA’s net FDI inflow was $64 billion.  The effects of the global financial crisis and falling commodity prices caused FDI inflows to Africa to fall to $59 billion in 2009 (UNCTAD, 2010).  FDI inflows to Africa in 2010 were $55 billion, 9 percent down from 2009.  Since other developing regions performed better, Africa’s share of FDI among developing countries fell from 12 percent in 2009 to 10 percent in 2010.  The recent secular decline in FDI followed through 2012 with the Arab Spring insurgence in North Africa.  Since the global rebound from the great recession, capital flows to the SSA region, in particular, rose from 2012 to 2013 when net FDI inflows to the region grew 16 percent to $ 43 billion in 2013, boosted by new hydrocarbon discoveries in many countries.  World Bank data show, furthermore, that gross capital formation rose an estimated 8 percent in 2013 to 23.4 percent of GDP and fueled expansion of the region’s production capacity.

Foreign direct investment (FDI) is considered crucial as an engine of technological development and economic growth, with much of the benefit arising from positive ‘spillover’ effects (Love and Lage-Hidalgo, 2000).  Kokko (1994) argues that this effect may arise from a process of competitive interaction between foreign and domestic firms.  Balasubramanyam et al. (1996) provide evidence that FDI is a major element of economic growth in developing countries, but that this effect is restricted to countries which have a relatively open, trade-promoting macroeconomic policy.  According to Morrisset (2000), openness to FDI not only enhances international trade but also contributes to integrating the host country or region into the global economy.  Bengoa and Sanchez-Robles (2003), Campos and Kinoshita (2002), Hansen and Rand (2006), and Li and Liu (2005) report a positive relationship between FDI and economic growth.

Guiliano and Ruiz-Arranz (2008) have also found that remittances boost economic growth in countries with less developed financial systems by providing an alternative way to finance investment and helping overcome liquidity constraints.   According to the World Bank (2007, p. 54), workers’ remittances are second only to FDI as a source of external financing and foreign exchange for developing countries.   In 2005, remittances totaled $188 billion; twice the amount of official assistance received by developing countries.  However, by 2009, remittance flows to developing countries reached $307 billion.  Mohapatra et al. (2010) projected that flows of remittances would reach $374 billion in 2012. African countries have been part of the overall rising global trend, although they receive only 4% of total global remittances.  Remittances increase the available incomes for recipients in enhancing their consumption demand.   By inducing intra-family or intra-community income transfers, remittances mitigate the effects of poverty in Africa by increasing the recipient’s income for purchasing goods and services[1].  In that sense, remittances augment recipient households’ resources, smooth consumption, provide working capital, and have multiplier effects through increased household spending (Gupta et al., 2007; Gupta, 2005; Diatta and Mbow, 1999; Findley and Sow, 1998). 

The recent surge in FDI from 2000 to 2008 to the SSA region, more recent decline and rebound along with the increased flows of remittances is motivation to understand whether FDI flows to SSA is influenced by remittances and market size.  Therefore, in this study we explore what is the likelihood that remittances and market size explain recent FDI inflows to SSA countries, and draw implications for the region’s market competitiveness.  The study includes forty countries in the SSA region for which data is available from 1981 through 2013.  It applies the unbalanced panel data set of forty SSA countries for the period 1981 through 2013.

**Note: This study is an improved version of another study that was presented at ACRIA 2 (in Nigeria) based on eleven selected African countries (including Libya, Algeria, Egypt, Botswana, Cameroon, Cape Verde, Djibouti, Kenya, Mauritius, and Nigeria) that was excluded from publication at the time.  We have taken into consideration the main criticism at the time of choosing a few countries.  In our trial run of the model, the results are surprisingly much better.  That is encouraging.  We believe this paper will be a better fit for the theme of ACRIA 6.

[1] Lucas and Stark (1985), identified pure altruism, pure self-interest, and tempered altruism (or enlightened self-interest) as the microeconomic determinants of remittances using evidence from Botswana.

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