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Foreign direct investment impact

List of Abbreviations

BBC: British Broadcasting Cooperation

FDI: Foreign Direct Investment

FT: Financial Times

IMF: International Monetary Fund

MOFTEC: Ministry of Foreign Trade and Economic Cooperation

NEPAD: The New Partnership for Africa's Development

OECD: Organisation for Economic Cooperation and Development

OFDI: Outwards Foreign Direct Investment

SADC: Southern Africa Development Community

UEMOA: Union Economique et Monétaire Ouest Africaine

UK: United Kingdom

UNCTAD: United Nations Conference on Trade and Development

UOM: University of Mauritius

USA: United States of America

WTO: World Trade Organisation

1.1 Definition of FDI

Foreign direct investment (FDI) arises when an investor located in a country (home country) buys an asset in a different country (host country) and manages the asset (WTO, 1996).This differentiates FDI from portfolio investment1 in overseas stocks, bonds and other monetary tools (OECD, 1978). Direct investment includes equity capital, reinvested earning and other capital (or intercompany debt transactions). FDI enterprises include supplementary companies (in which non-resident investors own more then 50% of the capital), associates (in which non-resident investors own 50% or less) and branches (wholly or jointly owned incorporated enterprises) (UNCTAD, 1999).

1.2 The impact of FDI in developing countries

1.2.1 General trend of FDI

Economic growth, new capital accumulation and aid to government are seen as the positive outcome of FDI in the host country (UNCTAD, 1992). This is why more and more countries support FDI inflow, particularly developing countries. Inflow of FDI in 1999 was just below US $ 1000 billions rising to over US $ 1.2 trillions in 2009 representing a fall of US $ 0.5 trillions from 2008 because of the world economic crisis (OECD, 2009; World Investment Report 2009) (See Table 1 in Appendices). The role of FDI in developing and transitional economies has grown drastically since the 1990's. Total inflow of FDI to developing economies rose from US $ 34 billion in 1990 to US $ 544.8 billions (see Table 2 of Appendices). Sub-Saharan Africa (SSA) is forecasted to comprise of 16.1 % of the world's inflow of FDI in 2009 (World Investment Report to 2011, 2007). The issue is therefore, what are the determinants attracting FDI to SSA and Mauritius especially from Chinese companies than the rest of the world.

1.2.2 The impact of FDI on an economy

The most common advantage discussed on previous literature of FDI is how it can help the host country move out of the vicious cycle of underdevelopment. Benign model (Moran, 1999), describes that the would-be host country is caught up in a poverty-loaded stability. This means that producing at low levels leads to low wages, leading to low savings and investment, which in turn keeps the level of productivity low. FDI can in theory crack this cycle by investing more than local citizens and providing better organisation, marketing and expertise to develop the yield (Gillis et al., 1996; Cardoso and Dornbusch, 1989). Input of capital and technology to local companies may make the national production curve move upwards. The benign model alternative focuses on the potential harmful interaction of the host economy with imperfectly cut-throat competition in the domestic market by FDI from overseas firms in imperfectly cut-throat competition on the international market (Moran, 1999). FDI will have a positive impact on emerging economies which will increase their trade zone and investment management (OECD, 1998).

FDI have the following impacts on the host countries in general (Chen, 1994):

1.3 General Determinants of FDI

On theoretical grounds, there are several determining factors of FDI. There is no conclusive evidence of any particular theory of foreign investment. In other words, there is no completely satisfactory theory on foreign investment. Dunning (1981) has classified three reasons as three sets of rewards for a company to go global: ownership, location and internalisation (the so-called OLI theory of eclectic theory). FDI made by multinational companies in a country can depend on these three factors mentioned above and discussed below:

Theoretically, these advantages give a clear indication why companies want to invest overseas although extra costs are involved when a company invest in a country where it is not familiar with the local markets and organisations (South Centre, 1997).

Also, many other theories explain FDI in several ways. For instance, Pitelis (1996) analysed the oligopolistic theory which is competition in a market where there are a few large firms dominating the market. Each firm in formulating its pricing and output policies or strategies will be obliged to incorporate the effect of its action on the rival producers and the possible course of action they might in turn pursue. 'Oligopolistic disequilibrium' took place in recent years in the global economy (South centre, 1997)2. The reason why FDI is taking place in the form of mergers and acquisitions especially in developed economies is explained by this theory.

According to Bradley (1999), if it is believed that a company has great and costless understanding which can be taken benefit of, the company is generally born with a geographical scope limited to an area or a home country, but now this horizon changes. Internal and external factors are the result of these changes. New product development, rising internal resource and administration devotion are the internal factors; strong competition, government regulations are examples of the external factors. Many companies increase their performance based on access to raw materials, new possible markets and increasing market share. Therefore Dunning (1988) acknowledged 4 stimuli for FDI:

The principle motivation for a company to look for new investment markets are because of the above 4 reasons, for example, low labour costs, easy access to raw materials, increase market share, and a more negligent attention to environment by some government. Therefore it is more proficient to produce goods in overseas countries than in the home country. Worldwide investment enables a firm to operate better, ease local resources and diminish risk, find new markets and sway government strategy.

According to literatures, the most common ways to determine the factors affecting FDI in developing countries are:

  1. Human capital and labour costs
  2. Infrastructure
  3. Market size/GDP, openness and export
  4. Natural resources
  5. South-South cooperation
  6. Political stability and corruption level
  7. Taxes and tariffs

These are discussed further in the next sections, firstly in general terms and then relating to Sub-Saharan Africa and Mauritius in respect to Chinese investment.

1.3.1 Human Capital & Labour Costs and FDI

Authors such as Root and Ahmed (1979), Schneider and Frey (1985), Lucas (1990), Borensztein et al. ,(1998), Noorbakhsh et al., (2001) and Aseidu (2002) all agreed that human capital has an important role to play in the attraction of FDI. Foreign investors require labour to have certain level of education, skills and health status which affects the size of FDI inflows discussed by Zhang & Markusen (1999). This is because skilled workforce is more productive and can be trained to new technologies easier. Investors usually have an overview on the education level by looking at the secondary education enrolment rate (SER) which is available from a country's Central Statistics Office in the labour sector.

The cost of labour has always been a core part of the overall production cost of companies. Variation in wages has been regularly discussed in empirical literature which is a fact in labour-intensive companies where high wage demands would restrict FDI. Nevertheless, high wage demands may occur because the country is receiving high FDI. Investors will therefore look also at the nominal wage rate in a country before considering investing. (Wheeler and Mody, 1992).

These are both resource-seeking determinants of FDI.

1.3.2 Infrastructure and FDI

Saggi (2000) suggested that developing countries require a good level of infrastructural facilities (.i.e. resource-seeking determinant of FDI) to be able to attract vast amount of FDI. Road and rail networks, information and telecommunication, harbour, airport, power, gas and water supply all form part of the infrastructure in a country which are available for households, public services and private companies. David Aschauer (1988), a Bates College professor, suggests that investment on infrastructure and FDI are complementary. Nations which devote a large proportion of their gross national product (GNP) to infrastructure enjoys a high level of FDI inflows.

To measure the level of infrastructure, one should take into consideration both the availability and reliability of the latter. Infrastructure is not of much use if it is not reliable. For instance, quality of the phone lines, internet connection or water supply. Availability to foreign investors is also is a key factor, for instance, will there be internet connection or accessible roads to the location of the company (Asiedu, 2002). A good level of infrastructure will decrease the cost of provision of these by foreign investors lowering costs for them (Dupasquier and Osakwe, 2005). In conclusion a country with good quality of infrastructure has potential of attracting more investment.

1.3.3 Market Size/GDP, Openness & Export and FDI

The host country's economic position and possible demand for its production locally and internationally are significant factors to consider before investing in a country. Scaperlanda and Mauer in 1969 said "once it reaches a threshold level that is large enough to allow economies of scale and efficient utilisation of resources" (Sawkut et al., 2007) FDI will flow in. FDI responds in an optimistic manner to important market size.

GDP growth is used as a substitute for market demand size (Wei et al., 1999). Real GDP per capita and FDI share a common relationship as confirmed in previous literature. Results from studies by Edwards (1990) and Jaspersen et al. (2000) showed that FDI is inversely related to GDP per capita using the inverse of income per capita as substitute for the return on investment. However some other studies showed a positive relationship between the two, for instance, Schneider and Fry (1985) and Tsai (1994). It is argued that high GDP per capita gives more prospects for inflow of FDI.

Literatures also show that openness encourages FDI but it depends on the type of investment (Hufbauer et al., 1994). The ratio of trade to GDP can be use to determine of openness of a country[1]. Foreign companies who want to trade in the host country may not want to setup a branch in the host country because of trade restrictions. Multinational companies will want to seek more open economies if are exporting.

Stern (1997) and Jun and Singh (1996) put forward that FDI and exports work together. FDI in developing countries is more responsive to demand from exports than local demands as showed in Lucas sample study of South Asian countries (1993). This is because foreign investors have a better experience on the international market increasing the host country's export (Muchielli and Chedor, 1999).

The level of inflation is also considered and may varied consequences depending on the economic level of the host country (Musila and Singué, 2006).

Market size/GDP, openness and export are the market-seeking determinant of FDI.

1.3.4 Natural Resources and FDI

As theories suggest, countries blessed by nature with natural resources (.i.e. resource-seeking determinants of FDI) such as oil, minerals and coal are better positioned to attract FDI. Not including this measure from the study especially from countries in Africa will not make it relevant (Asiedu, 2002). Literatures which also took into account natural resources as a determinant of FDI include Warner and Sachs (1995), Asiedu and Esfahani (2001) and the World development Indicators 2009. Dunning (1998) and Caves (1996) both considered the accessibility, expenditure and value of natural resources and their expansion as a major incentive for FDI in a country.

1.3.5 South-South Cooperation and FDI

The South -South Cooperation (SSC) are activities between southern countries which have recently become industrialised and less develop countries in south part of the globe. Emerging economies also form part of the SSC, therefore it includes China, Brazil, India and South Africa. This is a strategic asset seeking determinant of FDI. Activities include investments, trade, transfer of technologies resolving crisis in member countries. It was created by the United Nations in the late 1970's (Mann, 2006). Member countries have special agreements to promote cooperation amongst them such a very low tariffs to trade amongst them. There is however a severe lack of academic studies on the SSC as a determinant of FDI. SSC help to expand market size, improve infrastructures and educational level to gain more skilled labour in the future, help in political and social issues (lLewis, 1980; Antweiler and Trefler, 2002). This promoted FDI inflows to Southern countries to increase from 16% in 2005 to 37% in 1993 (World Bank, 2006). This has lead to creation of further smaller co operations groups, to encourage larger amount of FDI inflows from the North, such as in Africa there is the Southern Africa Development Community (SADC) and Common Market for Eastern and Southern Africa (COMESA). This has promoted more confidence in foreign investors to invest in developing countries.

1.3.6 Political Instability & Corruption and FDI

Political instability and corruption, which are efficiency-seeking determinants of FDI, have an impact of FDI because political issue in a country creates an environment discouraging and showing risk of investing in this country (Schneider and Frey, 1985). Risk of investing in a country can be analysed in the International Country Risk Guide issued every year. This can be divided into 2 categories: social factors and political factors.

Social factors consist of the quality of the labour force, crime rate, employee-employer relationship and the level of corruption and transparency. Corruption has an effect of increasing cost of investments [2] (Ancharaz, 2003). Good governance, stable democratic system and law application are positive political factors that encourage FDI. Foreign investors prefer to invest in a stable political economy as their capital will be safe, not at risk and no risk of production stoppage.

1.3.7 Government Policies, Taxes & Tariffs and FDI

Government can play a crucial role in stimulating foreign investment and is considered an efficiency-seeking determinant of FDI. For instance, increased government grants, investment tax allowances and less time taken to grant permits will be likely to increase investment. Higher corporate tax rates have and adverse effect on FDI and vice-versa approved by Kemsley (1998) and Billington (1999) but Wheeler and Mody (1992) prove tax rates and FDI to not have any relationship. It is argued that the interest rate is the most important determinant of FDI as both are inversely related as interest rate affects the actual cost of capital. This is shown in diagram 2 (Ancharaz, 2003).

Exchange rate are has an effect on investment decision from overseas investors as discovered by Revenga (1995) and Elbadawi and Mwega (1998). Theoretically, a depreciation of real exchange rate will increase FDI inflows. It can however be contrasted than FDI main purpose is to create and export from the home country and should not therefore worry the investors. This can also however be argued that a depreciating currency increase import costs and create a decline in foreign sales profits which are both unfavourable consequences to FDI. All these create conditions conclusive to FDI.

1.4 Determinants of FDI in Sub-Saharan Africa (SSA) and Mauritius to Chinese companies than the rest of the world

The World Investment prospect to 2011 show that SSA had an FDI inflow of US $ 8.4 billions in 1997. The biggest recipients were Nigeria and South Africa was shown in table A.2 (World development Indicators, 1999). During the last few years, there has been a significant increase in FDI in SSA leading to an inflow of US $ 16.1 billions in 2009, representing a new record figure.

Harque et al. (1999) argued that:

Investment rating services list Africa as the riskiest region in the world. Indeed, there is some evidence that Africa suffers from being perceived as a 'bad neighbourhood'. Analysis of the global risk ratings shows that while they are largely explicable in terms of economic fundamentals, Africa as a whole is rated a significantly more risky than is warranted by these fundamentals.

Collier and Gunning (1999, p.20)

Studies by Elbadawi and Mwega (1998), Wilhelms (1998) and Ancharaz (2003) analyses the determinants of FDI in SSA and Mauritius. China economy grow on an average of 10% since 1990's and trade with Africa increased by 700% from 1991 to 2000 (Lyons and Brown, 2009). November 2006 saw a conference between SSA and China following a first ever conference in 2000 between them, to strengthen relationships, increase investment both ways and increase trade. Mauritius saw an increase of Chinese FDI from US $ 10.27 Millions in 2003 to US $ 34.44 millions in 2008. The Chinese government is also investing US $ 750 millions over the next 10 years known as the 'Jin Fei Project' in Mauritius as a platform to increase trade and investment further in SSA and Africa in general (Oxford Analytica, 2009). There are several reasons why Chinese companies want to invest in SSA which is discussed in the next section of this paper.

1.4.1 Human Capital & Labour Costs and FDI

1.4.2 Infrastructure and FDI

1.4.3 Market Size/GDP, Openness & Export and FDI

1.4.4 Natural Resources and FDI

1.4.5 South-South Cooperation and FDI

1.4.6 Political Stability & Corruption and FDI

1.4.7 Taxes & Tariffs and FDI

1.5 Summary

1.6 Referencing

1.7 Bibliography

1.8 Notes

1.9 Appendices

  1. Gastanaga et al. (1998) measure the level of openness in a different manner, i.e., by computing "the degree of openness to inward FDI" and "the general openness to capital flows".
  2. A population that elects a military government is likely to reflect in to expenditure of the government and their goals.