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FDI in Southern Africa: Microeconomic Consequences and Macro Causes

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Foreign direct investment (FDI) can theoretically reduce income gaps between developing and advanced economies. In a neoclassical world, with perfect capital mobility and technology transfer, capital readily flows from rich to poor countries, seeking higher returns in capital-scarce economies. The real world differs starkly from the theory.

Even though southern African countries (the Southern African Development Community, SADC hereafter) are poor on average, per capita FDI inflows are a meager 36.6 U.S. dollars per year (in 2000 value), which is about 18 percent of average per capita FDI in non-SADC countries and 58 percent of the average level for similar-income economies. Moreover, within SADC, country differences are huge: FDI per capita ranges from single digits (Malawi, Zimbabwe, Madagascar, Democratic Republic of Congo, and Tanzania) to 10-30 dollars (Mozambique, Zambia, Mauritania, and Swaziland), to 50 to 100 dollars (Lesotho, South Africa, and Angola), and to 167 dollars in the outlier in this region, middle-income Botswana. And even within this region there is a positive relationship between average income and FDI per capita, a pattern that holds for the world as a whole. Thus, any hope of relying on FDI as a supply-side remedy to catapult poor countries onto a development fast track is not likely to materialize soon.

Perhaps with these low FDI numbers in mind, policymakers and development agencies are concerned about FDI performance in SADC countries. Although officials may hope that FDI can play a positive role in local economic development, it is not a given that this should be the case. It is possible that multinational corporations merely capture rents and  create jobs at the expense of other existing jobs. Further, technological spillovers may not materialize but instead foreign firms steal domestic markets away from domestic firms. The potential benefits of FDI may also differ across economic contexts, e.g. market size and the time-horizon of foreign capital, which itself is shaped by the institutional environment. This combination of wishful thinking and hard-nosed theoretical predictions puts empirical research in center stage.

The current literature has not addressed these issues for African economies, partly due to a lack of reliable and comparable micro data. But new data is now available. The World Bank’s investment climate surveys in this region offer comparable cross-country, firm-level data with information that allows us to link foreign ownership to firm performance and behavior in thirteen SADC economies.

In a paper we coauthored with Taye Mengistae, the evidence suggests that FDI has significantly facilitated development in the SADC region. Foreign firms tend to perform better, as measured by both sales growth rates and total factor productivity. An increase of foreign ownership by 10 percentage points is associated with increased sales growth of about 1.7 percentage points and productivity gains of about 1.5 percentage points. Foreign-owned firms tend to be larger, located in richer and better-governed countries with more competitive financial intermediaries. They are also more likely to export than domestic firms: the probability of exporting for a foreign-owned firm relative to a domestic firm is nearly 6 percentage points higher. This effect is quite large since the average probability of exporting for domestic firms is only 6.3 percent. More importantly, domestic firms tend to benefit from the presence of foreign firms operating in the same industry, thus suggesting that positive spillovers might be important: an increase of the percentage of foreign-owned firms in an industry by 10 percentage points appears to be associated with an increase in the productivity of domestic firms by about 2 percentage points.

Since we found positive effects of foreign ownership on local economies, we also examined the determinants of FDI in SADC by estimating an accepted empirical model of FDI inflows per capita (Fan et al. 2009). In addition, that paper looks for SADC-specific effects. However, we found an insignificant SADC-specific effect, implying that SADC is, in a sense, receiving the FDI that it deserves, given its average income, human capital, demographic structure, institutions, and economic track record. Simply put, the usual suspects explain SADC’s FDI performance.

To shed further light on the potential drivers of FDI for this region, we compared SADC with two groups of developing countries with higher FDI per capita. The factors that account for SADC’s lower FDI inflows are economic fundamentals: previous growth rates, income, phone density, and the adult share of the population. Interestingly, while income and infrastructure do not matter as much in SADC as in the rest of the world, openness (as measured by trade over GDP) matters more. This is consistent with the view that FDI to small countries is export-oriented.

Why do SADC countries have worse economic fundamentals? There are plenty of analyses shedding light on this question. Some of the potential culprits include ethnic polarization, political instability and civil wars, among others. To attract FDI to the region, these countries have to build fundamentally sound economies that naturally lure FDI. In addition, the results in Lederman, Mengistae and Xu (2010) indicate that openness is especially important for SADC. Policies and procedures to encourage openness would therefore be especially important for the region.

Further Reading:

Fan, Joseph, Randall Morck, Bernard Yeung, Lixin Colin Xu. 2009. "Institutions and Foreign Direct Investment: China vs. the Rest of the World," World Development 37 (4), pp. 852-865.

Lederman, Daniel, Taye Mengistae, Lixin Colin Xu. 2010. “Microeconomic Consequences and Macroeconomic Causes of Foreign Direct Investment in Southern African Economies,” World Bank Policy Research Working Paper 5416.


L. Colin Xu and Daniel Lederman

Lead Economist and Senior Economist

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