0115 966 7955 Today's Opening Times 10:00 - 20:00 (BST)

Effect of Foreign Direct Investment on Nigeria's Development

Disclaimer: This dissertation has been submitted by a student. This is not an example of the work written by our professional dissertation writers. You can view samples of our professional work here.

Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Chapter One

1.1 Introduction

The drying up in the early 1980’s of commercial bank lending to developing economies made most countries eased restriction on foreign direct investment (FDI) and many aggressively offered tax incentives and subsidies to attract foreign capital (Aitken and Harrison, 1999). Private capital flow to emerging market economies reached almost $200 billion in 2000. This is almost four times larger than the peak commercial bank lending years of the 1970’s and early 80’s. FDI now accounts for over sixty percent of private capital flow (Levine and Carkovic, 2002). However, while the explosion of FDI flow remains unmistakable, the growth effect remains unclear.

Foreign direct investment (FDI) has been a topic high on the policy agenda in emerging markets. This is due to the contributions FDI make to a country’s external financing and economic growth. The extent of regulation of FDI and other form of capital flow are also issues policymakers take a stand on and economic research has devoted a large effort to these issues. The experience of small number of fast-growing East Asian newly industrialized economies (NIEs), and recently china, has strengthened the belief that attracting FDI is needed to bridging the resource gap of low-income countries and avoiding further build-up of debt while directly tackling the cause of poverty (UNCTAD, 2005).

Even though the Asian crisis sounded a cautionary note to premature financial liberalization the call for more accelerated pace of opening up FDI have intensified on the assumption that this will bring not only more stable capital inflow but also greater technological know-how, higher paying jobs, entrepreneurial and workplace skills and new export opportunities (Prasad et al., 2003).

The increased importance of FDI has brought about international relationships, trade and policies materializing into export and imports between nations. This in turn results financial rewards to host countries. Policy makers across the region of Africa have hoped that attracting FDI with the bait of high tariff protection and generous incentives packages would provide the catalyst for a “late industrialization” drive (Thandika, 2001).

The debt crises in the early 80’s and policies introduced by several countries in Africa also witnessed increased FDI as necessary for economic development. The pursuit of responsible macroeconomic policies combined with an accelerating pace of liberalization, deregulation and above all privatization were expected to attract FDI to Africa (WorldBank, 1997). However, the record of the past two decades with respect to reducing poverty and attracting FDI as a result of policy changes has been disappointing at best (Ayanwale, 2007).

The importance of FDI varies across different sector in the recipient countries. However, in all major country groups, the extractive sector accounts for a significant share of inflow of FDI: for example, Australia, Canada and Norway among developed countries; Botswana, Nigeria and South Africa in Africa; Bolivia, Chile, Ecuador and Venezuela in Latin America and the Caribbean; and Kazakhstan in South-East Europe and the CIS (UNCTAD, 2006a).

The important of this sector is due to the fact that oil and gas are crucial to the contemporary global economy and their prices are key components of economic forecasts and performance. Crude oil and refined petroleum products constitute the largest single item in international trade, whether measured by volume or value (Steven, 2005). Thus, oil and gas are strategic resources in national, regional and global economies.

Despite this significant and strategic influence, empirical evidence suggests that oil and gas abundant economies are among the least growing economies (Sachs and Warner, 1997, Gelb, 1988, Stevens, 1991, Steven, 2005). This phenomenon is often conceived within the prisms of the “resource curse” and “Dutch disease”. Both of which are manifestations of inefficient utilization of resources rather than the inevitable outcome of the availability of oil and gas resources. The impact of FDI on economic growth of recipient country has been one of varying opinions among authors.

A huge literature exists concerning different effects of foreign investment on economic development in a recipient economy. Currently FDI sustains the most dynamic development in the world economy in comparison with other forms of foreign financing (De Gregorio, 1992). Most theoretical and empirical findings (see chapter 3) imply that FDI has a strong positive growth impact on the recipient economy.

Within the African context, the Nigerian economy is a unique case, not because it is a developing economy and is quite large, but because during last 15 years the country has not managed to attract significant amounts of FDI (Asiedu, 2002). Typically investment risks are so high in Nigeria that only high profits in export oriented extractive industries (e.g. fuel industry) have attracted much foreign direct investment. This sector exerts a prominent influence on the economy as a key revenue earner. While oil and gas resources have very high revenue yields due to increasing international demand the question of aggregate FDI impact on economic growth remains an open question. This paper attempts to find some answers. 

Over the last decade, the Atlantic Ocean off the coast of Western and Southern Africa has become one of the most promising oil exploration areas in the world with a convergence of interest between African governments, multinational oil companies, international Financial Institutions (Jerome et al., 2007). Nigeria falls among the six countries which have become key players in the world of energy stake. However, the economic record and lived experience of mineral-exporting countries has generally been disappointing.

The World Bank classification of Highly Indebted Poor Countries include: twelve of the world 25 most mineral dependent states and six most oil dependent. When taken as a group, all “petroleum rich” less developed countries has witnessed erosion in their living standards and many rank bottom one-third of United Nations Human Development Index. In addition to poor growth records and entrenched poverty, they are also characterized by high level of corruption and a low prevalence of democratization (Jerome et al., 2007).”

1.2 FDI Defined

Various classifications have been made of foreign direct investment. For instance, FDI has been described by the Balance of Payment Manual 5th edition (BPM5) as a category of international investment that reflects the objective of a resident in one economy (the direct Investor) obtaining a lasting interest of a resident in another economy (the direct investment enterprise). The lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence by the investor on the management of the enterprise.

A direct investment relationship is established when the direct investor has acquired 10 percent or more of the ordinary shares or voting power of an enterprise abroad (IMF, 1993). This comprises not only the initial transaction establishing the FDI relationship between the direct investor and the direct investment enterprise but all subsequent capital transactions between them and among affiliated enterprises resident in different economies (Patterson et al., 2004). Once a firm undertakes FDI, it becomes a multinational enterprise (MNEs).

Policymakers believe that foreign direct investment produces positive effects on host economies. Some of these benefits are in the form of externalities and the adoption of foreign technology which could be in the form of licensing, agreements, imitation, employee training and the introduction of new processes by the foreign firms (Alfaro et al., 2004). Multinational enterprises are said to diffuse technology and management know-how to domestic firms (Tang et al., 2008).

FDI is conventionally used as a proxy to measure the extent and direction of MNE activities (Jones, 1996). Like any other business, MNEs have a major objective of maximizing profit and reducing costs. Hence, MNEs consider regions with higher returns on investment and enabling environment for business success. This is one of the reasons for more FDI in some places than others. Accordingly MNE will invest higher in regions that provide the best mix of the traditional FDI determinants (Berg, 2003). The motivation for investment by multinationals in certain countries much more than others is discussed elaborately in chapter three

1.3. Background

The involvement of MNEs (through FDI) in extractive industries has had a chequered history. In the early twentieth century, these industries accounted for the largest share of FDI, reflecting the international expansion of firms from the colonial powers. With a growing number of former colonies gaining independence after the Second World War, and the creation of the Organization of the Petroleum Exporting Countries (OPEC) in 1960, the dominance of these MNEs s declined, as did the share of extractive industries in global FDI.

From the mid-1970s, in particular, the share of oil, gas and metal mining in world FDI fell steadily as other sectors grew much faster. However, as a result of rising mineral prices, the share of extractive industries in global FDI has recently increased, although it is still much lower than those of services and manufacturing. It is therefore an opportune timeto revisit the impact of FDI into theextractive industries has on economic development.

Measuring the effect of FDI on economic growth occupies a substantial body of economic literature. Many theoretical and empirical studies have identified several channels through which FDI may positively or negatively affect economic growth (Akinlo, 2003, Mello, 1997). Not many studies have reported on the effects of FDI in Africa and most existing studies have concentrated on economies with high FDI in the manufacturing industries unlike economies with high FDI inflow in the extractive sector (as the case of Nigeria).

Several factors suggest that the indirect benefits of FDI maybe less in extractive sector especially oil industries. Reasons given for this are that: firstly, the extractive sector (such as oil sub-sector) is often an enclave sector with little linkages with the other sectors. Secondly, the knowledge and technology embedded in the sector is extremely capital intensive and so transfer of knowledge and technology maybe less. Also, the capital requirement and large economies of scale may not attract new entrants into the sector as in the manufacturing sector. Furthermore, not all sector of the economy have the same potential to absorb foreign technology or create linkages with the rest of the economy (Hirschman, 1958). Finally, sales in this sector are foreign market oriented and require fewer input of materials and intermediate goods from local suppliers. Hence will have less forward and backward linkages (Akinlo, 2004). The sensitivity of project to world commodity price also make it been view as a volatie sector (WorldBank, 2005)

Given the pattern of foreign direct investment flow to Nigeria (mostly in oil and gas sector) and the angst-ridden as regards the benefits from the extractive FDI, it is apposite to examine empirically the situation in Nigeria. This constitutes the objective of this research. An analysis of this will be done for the period between 1980 and 2006

1.4 Overview of Foreign Direct Investment

1.5 Natural Resources and Economic Development

Since the 1950’s, economists have been concerned that economies dominated by natural resources would somehow be disadvantaged in the drive for economic progress. In the 1950’s and 1960’s, this concern was based upon deteriorating terms of trade between the “centre” and “periphery” (Prebisch, 1964) coupled with concern over the limited economic linkages from primary product exports to the rest of the economy (Hirschman, 1958). In the 1970’s, it was driven by the impact of the oil shocks on the oil exporting countries (Wijnbergen and Van, 1986, Mabro and Monroe, 1974).

In the 1980’s, the phenomenon of “Dutch Disease” (the impact of an overvalued exchange rate on the non-resource traded sector) attracted attention (Corden, 1984). Finally in the 1990’s, it was the impact of revenues from oil, gas and mineral projects on government behaviour that dominated the discussion (Stevens, 1991, Gelb, 1988).

The common thread running through these concerns is that the development of natural resources should generate revenues to translate into economic growth and development. Thus the revenues accruing to the economies should provide capital in the form of foreign exchange overcoming what was seen as a key barrier to economic progress. This could be explained both in terms of common sense (more money means a better standard of life) and development theories - the requirement for a “big-push” (Murphy et al., 1989), capital constraints (Lewis, 1955, Rostow, 1960) and dual-gap analysis (Shibley and thirlwall, 1981).

However, the reality appeared to be the reverse. Countries with abundant natural resources appeared to perform less well than their more poorly endowed neighbors. Thus the term “resource curse” began to enter the literature (Vanderlinde, 1994). More recently there has been a revival of interest in the phenomenon of “resource curse”. Furthermore, this has drawn the attention of a much wider audience than previously.

Growing concern among a number of non-governmental organizations (NGO’s) regarding the negative effects of oil, gas and mineral projects on developing countries has had several effects. It has forced the World Bank group to consider their role in such projects. This has culminated in the creation of “the Extractive Industry Review” based in Jakarta to consider whether the World Bank Group should, as a matter of principle, have any involvement with such projects. Disagreement within and between the World Bank and the IMF have further fuelled the debate over how such revenues should be managed. 

NGO concern has also encouraged the more responsible petroleum and mineral corporations to consider the impact of their investment in such projects on the countries concerned. However, in the literature that has focused on “resource curse”, there are references to countries that allegedly managed to avoid a “curse” and instead received a “blessing”. For example, even the report produced by Oxfam America (Ross, 2001) which is strongly negative towards such projects, states … “There are exceptions: some states with large extractive industries – like Botswana, Chile and Malaysia – have overcome many of the obstacles … and implemented sound pro-poor strategies”. There are similar references elsewhere to “success” stories – Botswana (Hope, 1998, Love, 1994), Chile (Schurman, 1996), Indonesia (Usui, 1996), Malaysia (Rasiah and Shari, 2001), and Norway (Wright and Czelutsa, 2002).

Nigeria is Africa’s most populous country with close to 132 million inhabitants. However, approximately 55% of the population lives on less than the value of one US dollar per day. The Nigerian economy depends heavily on the oil sector, which contributes 95% of export revenues, 76% of government revenues and about a third of gross domestic product. Before the establishment of democracy in 1999, the country was governed by military generals, under whose rule Nigeria’s economic performance had taken a beating for 15 consecutive years (Datamonitor, 2007).

Nigeria has a dual economy with a modern segment dependent on oil earnings, overlaid by a traditional agricultural and trading economy. At independence in 1960 agriculture accounted for well over half of GDP, and was the main source of export earnings and public revenue. The oil sector, which emerged in the 1960's and was firmly established during the 1970's, is now of overwhelming importance to the point of over-dependence.

Undoubtedly, Africa and indeed Nigeria is facing an economic crises situation featured by inadequate resources for long-term development, high poverty level, low capacity utilization, high level of unemployment and other Millennium Development Goals (MDGs) increasingly becoming difficult to achieve by 2020. Foreign direct investment has assumed prominent place in her strategy as a way of boosting economic rival and growth. It is also seen by policy makers at all levels as a way of bridging the resource gap of the country and avoiding further debt build-up (UNCTAD, 2005).

This has brought about several changes in policy and regulations in order to encourage foreign investor to invest in the country. Other measures include – the liberalization of the foreign investment regime to allow major foreign ownership, lifting foreign exchange controls and the privatization of Nigeria’s public enterprises. This research is aimed to take an in-depth analysis of the major private capital flow - foreign direct investment to a growing economy; Nigeria. This investment trend will be narrowed down to the extractive sector and in particular the oil and gas sector with the aim of investigating how investment in this sector translate to economic growth.

1.6 Research Gap

During the last decade, a number of interesting studies in the role of foreign direct investment in stimulating economic growth has appeared. Several authors have observed that the major reason for increased effort in attracting more FDI has been stemmed from the belief that FDI has several positive effects (Levine and Carkovic, 2002, Caves, 1996).

In contributing to the importance of FDI, it has also been shown that FDI is three times more efficient than domestic investment (De-Gregorio, 2003). Available evidence for developed countries seems to support the idea that productivity of domestic firms is positively related to the presence of foreign firms (Globerman, 1979). The result for developing countries are not clear, with some finding positive spillover (Blomstrom, 1986, Kokko, 1994), and others reporting limited evidence (Aitken et al., 1997).

Earlier studies on FDI showed that target countries receive very few benefits and in most cases negative effect on economic growth (Singer, 1950; Prebisch, 1968; Saltz, 1992; Bos et al., 1974 cited in (Katerina et al., 2004). A positive effect is only contingent on the ‘absorptive capacity’ of the host country (Durham, 2004). Many research have shown that FDI stimulates economic growth (Borensztein et al., 1998, Amy Jocelyn and Kamal, 1999) as seen in china’s economic growth (Dees, 1998 cited in (Ayanwale, 2007) and Latin American countries (Mello, 1997) showing that inflow of capital brings about increase in investment level.

FDI has also been shown to have both a positive and negative effect on economic development depending on the variables[1] that are used along side the test equation (UNCTAD, 1998; 1999). Its effect has also been more positively acclaimed in countries with higher institutional capabilities (Olofsdotter, 1998) and economically less advanced countries (like Philippines and Thailand) but negatively on more economically advanced countries like Japan and Taiwan (Bende-Nabende and Ford, 1998). In essence, the impact FDI has on growth of any economy may be country an period specific and as such there is a need for country specific studies.

Several studies have shown varying relationship between FDI and economic growth in Nigeria. For example, Odozi (1995) study showed that Structural Adjustment Policies (SAP hereafter) of Nigeria contributed to the FDI-growth relationship. He revealed that macro-policies before SAP discouraged foreign investors. Ogiogo (1995) reported a negative contribution of public investment to GDP growth for the reason of distortion. However, positive linkage effect of FDI-growth relationship was shown by Aluko (1961). Private domestic investment was also shown by Ariyo (1998) to contribute positively to raising GDP-growth rate for the period 1970-1995.

Oyinlola (1995) using Chenery and Stout’s two-gap model found a positive relationship between FDI and economic growth. Ekpo (1995) using time series data revealed that political regime, real income per capita, inflation rate, credit rating and debt service were key factors explaining variability in FDI into Nigeria. Using unrelated regression model, FDI was shown to be pro-consumption and pro-import hence showing a negative relationship to domestic investment (Adelegan, 2000 cited in Ayanwale, 2007) and statistically insignificant effect was shown for FDI-growth (Akinlo, 2004).

More recent findings by Ayanwale (2007) revealed that FDI contributes positively to Nigeria’s economic growth with the communication sector accounting for the highest potential to grow that economy. He also opined that FDI in the manufacturing sector has a negative relationship with economic growth suggesting that the business climate is not healthy enough for the manufacturing sector to thrive and contribute to positive growth.

Crude oil discovery and exploration has been said to have both positive and negative effect on Nigeria. The negative side is seen in term of the environmental degradation, deprived means of livelihood and other economic and social factors experienced by surrounding communities where the oil wells are exploited while the positive side is viewed from the large proceeds from domestic sale and export of petroleum products. However, its effect on the growth of the Nigerian economy as regards returns and productivity is still questionable (Odularu, 2007).

This review shows that the debate on the impact of FDI on economic growth is far from being conclusive. The role of FDI can be country specific and its relationship with growth can either be positive, negative or insignificant depending on the macroeconomic dispensation (economic, institutional and technological conditions) in the recipient country (Zhang, 2001). Even though none of these studies controlled for the fact that must of the FDI was concentrated in the extractive industry, they did not specifically investigate the relationship between oil-FDI and economic growth. This is the focus of this study.

1.7 Research Objectives and Questions

Few research on FDI into Sub-Saharan Africa have shown empirical evidence of FDI and economic growth as ambiguous (Ayanwale, 2007). In theory FDI is believed to have several positive effects on the economy of host country (such as productivity gains, technology transfers, the introduction of new processes, managerial know-how and skills, employee training etc), promoting its growth and in general, a significant factor in modernizing the host country’s economy (Katerina et al., 2004). However, there is no clear understanding of its contribution to growth (Bora, 2002).

This research was driven by the following questions:

Has foreign direct investment into Nigerian oil and gas sector brought about economic development?

What is the transmission mechanism through which FDI brings about growth

1.8 Methodology

1.9 Dissertation Outline

The rest of the paper is organized as follows:

Chapter Two:

This chapter is the literature review and shall be discussed in three subsection. The first two sections shall seek to review the theories and motivation for Foreign direct investment and the third section deals with the theoretical and analytic review of literature on FDI - Growth linkages. This shall seek to answer the question on the mechanism through which FDI result in economic growth.

Chapter Three:

This chapter discusses the case study - Nigeria and reviews the contribution performance and challenges of the oil and gas sector in Nigeria. Also, the impact of this sector on economic growth is discussed.

Chapter Four:

The methodology and theoretical framework for the analysis is the objective of this chapter. This section discusses the research approach and data collection mode. The variables for analysis and the model for shall be derived.

Chapter Five:

Data Analysis of the result and findings shall be the aim of this chapter.

Chapter Six:

This chapter shall form the conclusion of the research and give a summary of the findings, suggestion for improving economic growth in Nigeria and recommendation for further study.

Chapter Three

Literature Review

3.0 Introduction

Foreign direct investment is in general motivated by both “pull” and “push” factors. The push factors are external to developing countries and focuses majorly on growth and financial market conditions in industrial countries. On the other hand, the pull factors are dependent (on a lot of factors) domestic policies and characteristics of host countries. While the push factors determine the totality of available resources, the push factors determine its allocation between countries (Ajayi, 2004).

The diversity of theoretical and empirical explanations for the impact and influence of FDI (and growth) is without doubt very rich. Many studies among others have emphasized conducive macroeconomic policy, increased liberalization of markets, large domestic markets, liberal trade regime, low labour cost, availability of natural resources, good infrastructure and investment in human capital (bring about an educative workforce) (Ajayi, 2003).

This review therefore draws from many of these works with the particular aim of providing an understanding of the theoretical and empirical background, views and present thought on the relationship between FDI and economic growth.

The discussion shall be presented in three sections. The first two sections shall discuss the theories and motivation for FDI and the third section involves theoretical and empirical review of the literature of FDI and economic growth from four perspectives: trade or export (openness), linkages and spillover effect, knowledge and technology transfer and human capital.

3.1 Theories of FDI

FDI can take the form of a Greenfield investment in a new facility or an acquisition of or merger with an existing local firm. Majority of cross-border investment is in the form of merger and acquisition rather than Greenfield investments. According to estimates by United Nations, 40 to 80 percent of all FDI inflows between 1998 and 2005 were in the form of mergers and acquisition (Hill, 2009). However, FDI flows into developed nations are different from those of developing nations. For developing nations only about one- third of FDI is in the form of cross-border merger and acquisition. This may simply reflect the fact that there are fewer firms to acquire in developing nations (Hill, 2009).

For the purpose of this research, I have concentrated on two theories of FDI which are relevant to the study. The first perspective explains why firms in the same industry often undertake FDI at the same time and why certain locations are favoured over others (i.e. the observed pattern of FDI). The second is known as the eclectic paradigm. This perspective is eclectic because it combines the best aspects of other theories into a single explanation.

In proceeding with the discussion, we define some terms. When goods are produced at home and then shipped to the receiving country for sale, it is known as exporting. The process of granting a foreign entity (the licensee) rights to produce and sell the firm’s product in return for a royalty fee on every unit sold is known as Licensing.

Foreign direct investment has been view as an expensive and risky venture compared to exporting and licensing. This is because firms bear the cost of establishing production facilities in a foreign country or acquiring a foreign enterprise and the risk of doing business in countries with different culture. In exporting, firms need not bear cost associated with FDI and risk can be reduced by the use of local sales agents. Similarly, under licensing, the licensee bears the cost and risks. However, it is worth noting in summary that firms will choose FDI over exporting as an entry strategy when transportation costs or trade barriers make exporting unattractive. Furthermore, firms will favor FDI over licensing (or franchising) when it wishes to maintain control of technological know-how or over its operations and business strategy or when firm’s capabilities are simply not amenable to licensing (Hill, 2009).

3.1.1 The Pattern of FDI Strategic Behaviour

The idea that FDI flow reflects strategic rivalry between firms in the global marketplace is the basis for one of the theories of FDI. In studying the relationship between FDI and rivalry in oligopolistic industries F. T. Knickerbocker proposed a variation to this argument. An oligopoly is an industry made up of a small number of large players (for example, an industry in which four firms control 80 percent of a domestic market). One key features of such market is the interdependence of major players: the action of one firm have immediate impact on the major competitors, forcing a response in kind.

This interdependence leads to imitative behaviour; rivals are usually quick to imitate opponents in and oligopoly – “the bandwagon effect”. Imitative behaviour can take many forms in an oligopoly. Some good examples are price war and capacity increase. Rivals imitate lest they be left at a disadvantage in the future. F. T. Knickerbocker argued that the same kind of imitative behaviour characterizes FDI.

Although Knickerbockers’ theory and its extensions can help to explain imitative FDI behaviour by firms in oligopolistic industry, it does not explain the choice and efficiency of FDI over exporting or licensing. This is explained by the internalization theory. The Product Life Cycle Theory

The product life cycle theory was proposed by Raymond Vernon in the mid-1960s and was based on the observation that for most of the 20th century, a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market (e.g. automobiles, photocopiers, televisions and semiconductor chips). Vernon opined that the wealth and size of the U.S. market gave U.S. firms a strong incentive to develop new consumer products and the high labour cost also gave firms in the U.S. an incentive to develop cost-saving process innovations.

The theory went further to argue that early in the life cycle of a typical new product, while demand is starting to grow rapidly in the United States, demand in other advanced countries does not make it worth while for firms in those countries to start producing the new product, but it does necessitate some export from the United State to those countries. However, over time the demand for new product starts to grow in other advanced countries. As this happens, foreign producer begin to produce at home for their own market and growing demand causes U.S. firms to setup production facilities in those advanced countries. This limits the potential for export for the United States. Finally, at maturity product becomes standardized, cost consideration start to play a greater role in the competitive process and producer in advanced countries with lower labour cost than the U.S. might now begin to export to the United States. Under intense cost pressure, the cycle by which the United State lost its advantage to other advanced countries might be repeated once more as developing countries begin to acquire a production advantage over advanced countries (Hill, 2009).

The effect of these trends is that over time the United States switches form being an exporter of the product to an importer of the product as production becomes concentrated in lower-cost foreign locations.

The product life cycle seems to be an accurate explanation of international trade patterns. However, the product life cycle is not without weakness. When viewed from an European or Asian point of view, the argument that most new product are developed and introduced in the United States seems ethnocentric. Even though this may be true (from 1945 – 1975) during the U.S. dominance of global economy, there have always been exceptions which have become more common in recent years. For example video game consoles where first introduced in Japan, new wireless phones in Europe. More so, with increased globalization and integration of the world economy, a growing number of new products (e.g. laptop computers, digital cameras and compact disc) are now introduced simultaneously in the United States, Japan and advanced European nations (Hill, 2009).

Vernon’s theory also fails to explain why it is profitable for firms to undertake FDI at such times rather than continuing to export from it home base and licensing a foreign firm to produce its product. Large foreign demand does not necessarily mean profitable local production as it may still be more profitable option to produce at home and export to that country or alternatively license product to foreign company to produce its product for sale in that country.

Hence it ignores these options and rather argues that once foreign market is large enough to support local production, FDI will occur. The theory’s failure to identify when it is profitable to invest abroad limits its explanatory power and its usefulness.

In summary, although the product life cycle theory as proposed by Vernon may be useful in explaining the pattern of international trade during the period of U.S. global dominance, its relevance in modern seems more limited.

3.1.2 The Eclectic Paradigm

The eclectic paradigm was championed by British economist John Dunning. Dunning opined that location-specific advantages are also of considerable importance in explaining the rationale for and the direction of FDI. According to Dunning, location-specific advantages refer to advantages arising from the utilization of resource endowment or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets (such as management capabilities and technological know-how). The difficulty for a firm to license its own unique capabilities and know-how which is an argument of the internationalization theory was acknowledged by Dunning. Hence stating that combining location-specific assets or resource endowment with firm’s own unique capabilities often requires foreign direct investment. That is, it requires firm to establish production facilities where those foreign assets or resource endowments are located (Hill, 2009).

Natural resources, such as oil and other minerals which are by their character specific to certain locations is an obvious example of the Dunning’s argument. To exploit such foreign resources, a firm must undertake FDI. This clearly explains the FDI undertaken by many of the worlds oil companies (such as Shell, ExxonMobil, Chevron, British Petroleum and Total) which invest where oil is located in order to combine their technological and managerial capabilities with valuable location-specific resources as is evident in the case of Nigeria.

Another reason for FDI is valuable human resources such as low-cost, highly skilled labour. The cost and skill of labour varies from country to country. Since labour is not internationally mobile, according to Dunning, it makes sense for a firm to locate production facilities in those countries where cost and skills of local labour are most suited to its particular production processes (Hill, 2009).

Location-specific advantage as proposed by Dunning also comes from the sheer concentration of intellectual talent in an area and also from networks of informal contact that allows firms to benefit from each other’s knowledge generation. An example of such location-specific advantage is Silicon Valley which is the world center for the computer and semiconductor industry. Economists refer to such knowledge “spillovers” as externalities and a well established theory suggest that firms benefit from such externalities by locating close to their source (Krugman, 1991). For example, it has been argued that direct investment of foreign firms in the U.S. biotechnology industry has been motivated by desires to gain access to the unique location-specific technological knowledge of U.S. biotechnology firms (Weijian and Jaeyong, 1997). Dunning’s theory therefore, seems to be a useful addition to the earlier theories as it helps explain how location factors affect the direction of FDI (Lance Eliot et al., 1999).

3.2 Motivation for FDI

Although traditional explanations of FDI and international production generally apply also to the extractive industries, at least three specific features of resources extractions should be kept in mind:

Most investment in the extractive industry is capital intensive and risky with long gestation periods. Hence requires huge capital and ability to manage high risk (Vernon, 1971).

Mineral extraction (more than other sectors) can engender considerable environmental and social impact that investors need to address.

Mineral resources notably oil and gas are regarded as strategically important to countries, hence motivations other than purely economic ones often influence investment decision.

The motivation for FDI in the extractive sector can be grouped into the following four categories as opined by (UNCTAD, 1998, Dunning, 2000):

a) Resource-seeking b) Market-seeking c) Efficiency-seeking d) Strategic asset-seeking

3.2.1 Resource - Seeking

Natural resource-seeking dominates FDI and other form of MNEs involvement in upstream (exploration and extraction) activities. The reason for this include meeting the needs of its own downstream refining or manufacturing activities, selling to host, home or international markets or to secure the strategic requirement of energy or other minerals for its home country (as formulated by the country’s government) (UNCTAD, 2007).

Recently, the growing demand for various minerals has been the key driver of FDI (Kevin, 2006, Hoyos, 2007, David Zweig and Bi, 2005). For example, china’s “going global” strategy outlined in 2000 is among the most explicit recent step taken to boost FDI (UNCTAD, 2006).

3.2.2 Market - Seeking

FDI is viewed as a proactive mean of MNEs in seeking new markets for their products and services. This is done for many reasons such as profit advantage, unique products, patents, exclusive market information and tax benefits. FDI is perceived as a potential source of higher profits quite often because of the size of the market (Ghauri, 2000).

Even though this features among drivers of FDI in downstream activities, it is generally of limited importance for exploration and extraction activities. For mineral rich countries like Russia, Kuwait and Saudi Arabia based primary in the upstream sector, their market seeking position can be strengthened by moving to downstream market and capturing the value-added associated with the production and sale of finished products (Baker, 2007). Also, since relative profit between upstream and downstream activities vary over time, this form an opportunity for firms to diversify and mitigate risk.

3.2.3 Efficiency – Seeking

This is often time combined with market seeking motive especially when transportation of product is difficult or costly. In the case of refining, minimizing the cost of transportation may justify processing close to the source of the minerals while consideration of access to market and maximizing the scale of production may prompt locating it closer to consumer (Marina Elisabete Espinho et al., 2006).

3.2.4 Strategic Asset – Seeking

This is linked especially to the increase in cross-border Mergers and Acquisition (M&A) in the extractive industry. companies may invest to acquire strategic assets in the form of know-how and technology from the other companies or form specialized technology providers or speed up their rise to global status by accessing the resources, capabilities and market of acquired form (Dunning and Narula, 1998). Also, pre-emptive motivation may cause firms to merge with competitors to eliminate competition and erect barriers against others thereby strengthening their global position (caves, 1971).

3.3 Theoretical and Empirical Review of Literature

3.3.1 The FDI - Growth Linkages

Foreign direct investment has been widely acclaimed as a key ingredient of successful economic growth and development in developing countries – partly because the very essence of economic development is the rapid and efficient transfer and cross-border adoption of “best practice” (Ajayi, 2006). One way through which occurs is by upgrading human capital (Klein et al., 2001).

Growth is a necessary ingredient applauded to bring about reduction in poverty. Since growth can be fostered by FDI, then it is central to poverty reduction (especially for African nations in achieving their MDGs). Theory provides conflicting prediction concerning the growth effect of FDI. According to Addison and Mavrotas (2005) there are several ways in which FDI play a role in overall growth process. Some of which include:

Capital accumulation (physical and human): the nature of well designed FDI projects raise growth and lead to creation of jobs and employment growth which reduces income-poverty.

Revenue: FDI acts as a source of the much needed revenue by government for infrastructure and service development. This revenue effect can be direct or indirect. The direct aspect relates to corporate taxes by MNEs and revenue from FDI in the natural resource sector. The indirect aspect relates to the rise in economic growth translating to improvement in the total tax base.

Macroeconomic studies in most existing literatures also support the positive role of FDI and identifies three main channels through which FDI can bring about economic growth. These are:

FDI augments domestic savings in the process of capital accumulation

FDI acts as a conduit for technological transfer which brings about increase in factor productivity and efficiency in resource utilization leading to growth.

FDI leads to increase in export due to increased capacity and competitiveness in domestic production.

Empirical analysis of the positive relationship is often said to depend on other factors such as the “absorptive capacity” of the host country, and includes the level of human capital development, types of trade regime and degree of openness.

The preceding review takes a theoretical and empirical review of the FDI – Growth linkage and concentrates on four aspects: Trade and openness, knowledge and technology transfer, spillovers and human capital. Knowledge and Technology Transfer


Knowledge and technology diffusion plays a central role in the process of economic development (Barro and Lee, 1993). In contrast to the traditional growth framework, where technological change was left as an unexplained residual, the recent growth literature has highlighted the dependence of growth rates on the state of domestic technology relative to that of the rest of the world. Thus, growth rates in developing countries are, in part, explained by a ‘catch-up’ process in the level of technology. In a typical model of technology diffusion, the rate of economic growth of a backward country depends on the extent of adoption and implementation of new technologies that are already in use in leading countries. Technology diffusion can take place through a variety of channels that involve the transmission of ideas and new technologies. Imports of high-technology products, adoption of foreign technology and acquisition of human capital through various means are certainly important conduits for the international diffusion of technology (Barro and Lee, 1994).

Besides these channels, foreign direct investment by multinational corporations (MNCs) is considered to be a major channel for the access to advanced technologies by developing countries. MNCs are among the most technologically advanced firms, accounting for a substantial part of the world’s research and development (R & D) investment (Borensztein et al., 1998). The role of foreign direct investment in technological progress of developing countries has been highlighted by recent work. For example, Findlay (1978) postulates that foreign direct investment increases the rate of technical progress in the host country through a ‘contagion’ effect from the more advanced technology, management practices, etc. used by the foreign firms.

Wang (2009) incorporates this idea into a model more in line with the neoclassical growth framework, by assuming that the increase in ‘knowledge’ applied to production is determined as a function of foreign direct investment (FDI). Economists argue that multinational enterprises, through FDI, can help to fill an "idea gap" between developed and developing or host countries and provide greater opportunities for growth in the host markets (Romer, 1993).

Boyd and Smith (1992) however argued to the contrary. According to them, FDI can affect resource allocation and growth negatively where there is price distortion, financial, trade and other forms of distortions existing prior to FDI injections. Wheeler and Mody (1992) also supports the view of Boyd and Smith (1992). According to Wheeler and Mody (1992), infrastructure enhances FDI’s contributions by reducing their operating costs and increasing the productivity of investments. In other words, the growth impact of FDI is not automatic but tied to certain levels of infrastructure and economic performance. While these arguments may be valid theoretically, this relationship has been shown to exits empirically as we see in the empirical literature.


Empirical contributors to FDI debate include (Borensztein et al., 1998) Borensztein, De Gregorio and Lee (1998). They examined the effect of FDI on economic growth using data on FDI flows from industrial countries to 69 developing countries over the last two decades. Their regression results suggest that FDI is an important tool for technology transfer and it has contributed to growth more than domestic investment. However, the higher productivity of FDI can be realized more when the host country has a minimum threshold stock of human capital.

In addition, FDI has the potentials of increasing total investment more than one for one. The effect of FDI on economic growth appears to have become quite explicit with multinational enterprises acting as the primary vehicle for the international transfer of technology (OECD, 1991). The above point shows the complementary effect of FDI on domestic firms. Even though most empirical literature is contingent on additional factors within the host country, FDI has been shown to positively correlate with growth and the transmission mechanism generally focuses on the first beneficial characteristic of FDI – the dissemination of advanced technology (Durham, 2004). Thus

↑FDI ⇒↑Productive Technologies ⇒↑Output ⇒↑ Economic Growth SPILLOVER EFFECTS


The economic rationale for offering special incentives to attract FDI frequently derives from the belief that foreign investment produces externalities in the form of technology transfers and spillovers. Romer (1993), for example, argues that there are important “idea gaps” between rich and poor countries. He notes that foreign investment can ease the transfer of technological and business know-how to poorer countries. These transfers may have substantial spillover effects for the entire economy. Thus, foreign investment may boost the productivity of all firms not just those receiving foreign capital (Rappaport, 2000). Findlay (1978) postulates that FDI increases the rate of technical progress in the host country through a "contagion" effect from the more advanced technology and management practices used by foreign firms. This contagion or knowledge diffusion is often referred to as “externalities or spillovers” and can lead to improvements in productivity and efficiency in local firms in several ways. The argument of a generation of productivity spillover by FDI is supported by the work of Lim (2001) and Borensztein, De Gregorio, and Lee (1998).

Furthermore, according to Perez (1997) moderate foreign presence is sufficient to generate positive spillovers even when there is relatively wide technological gap between the foreign and locally owned industry. Caves (1974) proposed that the beneficial effects of FDI through MNEs can be categorized in terms of allocative efficiency, technical efficiency and technology transfer. Allocative efficiency gains are thought to arise from pro-competitive effects. Technical efficiency improvements spring from the demonstration of superior practice by foreign owned enterprise (FOE). With technology transfer, the presence of FOEs furnishes local firms with access to advanced technology on favourable terms (Susan and Sumit, 2001). This effect has been assumed to be linear (Peter et al., 2007).

In its simplest form, a spillover can occur when a local firm improves its productivity by copying some technology used by multinational affiliates/corporation (MNC) in the local market. Another type occurs when local firms are forced to use existing technology and resources more efficiently, or to search for more efficient technologies, because an MNC's entry has increased competitive pressure in the local market. In addition, spillovers can occur when an affiliate demonstrates new techniques to and trains local workers, who later accept employment in local firms or start their own firms (Lim, 2001).

Location-specific advantage as proposed by Dunning comes from the sheer concentration of intellectual talent in an area and also from networks of informal contact that allows firms to benefit from each other’s knowledge generation (e.g. Silicon Valley). Economists refer to such knowledge “spillovers” as externalities and a well established theory suggest that local firms would benefit from such externalities with the presence of foreign firms locating close to their source (Krugman, 1991).

A particularly significant channel for spillovers is through the linkages between the MNC affiliate and its local suppliers and customers. Lall (1980) identifies the following MNC/supplier interactions that can help increase the productivity and efficiency of local firms:

Helping prospective suppliers set up production facilities;

Demanding from suppliers reliable, high quality products that are delivered on time, while also providing the suppliers with technical assistance or information to help improve the products or facilitate innovations;

Providing training and help in management and organization; and Assisting suppliers to find additional customers including their sister affiliates in other countries. Such suppliers may then start to export to the sister affiliates as well as to other independent external purchasers.


Blomström and Persson (1983) and Blomström (1986)(1986) find that FDI has created significant positive spillover effects on the labor productivity of domestic firms. Since Caves’ (1974) influential work on spillovers in Canadian and Australian manufacturing, an extensive empirical literature has emerged, bearing mixed results. Overall, the greatest number of enquires finds evidence for a positive relationship dominates.

These works find evidence that FDI enhances local owned enterprises (LOE) productivity (Caves, 1974, Globerman, 1979, Xiaming et al., 2000, Gangti and Kong Yam, 2000). Others report negligible or inconclusive effects (Haddad and Harrison, 1993). Fewer and more recent studies find negative spillover effects on the performance of LOEs (Ram, 1992, Aitken and Harrison, 1999, Jozef, 2000, Peter et al., 2002). In defense of these conflicting findings, differences between data sets and periods of measurement have been widely involved (Holger and Eric, 2001). Thus,

↑FDI (MNE Presence) ⇒↑Spillovers ⇒↑ Economic Growth TRADE OPENNESS


Many studies have looked at the relationship between trade and economic growth (Sachs et al., 1995b, Jeffrey and David, 1999, David and Aart, 2004). As predicted by the standard theory of comparative advantage (by Ricardo), countries that adopt a more open stance towards international trade enjoy higher growth rates than those that close their economies to trade. Also, according to Samuelson (1962) the opening up of an economy to trade is likely to generate dynamic gains of two sort. First free trade might increase a countries stock of resources as increased supplies of labour and capital from abroad become available for use within the country.

Secondly, free trade might also increase the efficiency with which a country uses its resources. This could come through making of better technology from abroad available to domestic firms; better technology in turn increases labour productivity or the productivity of land. Also, opening, an economy to foreign competition might stimulate domestic producers to look for ways to increase their efficiency (Caves, 1996). As a consequence, the direct and indirect effects of FDI together enhance the host country’s export performance.

The export led growth (ELG) hypothesis also states that exports are the main determinants of overall growth. At the heart of the ELG model are beliefs that

The export sector generates positive externalities on non-export sectors in the economy through more efficient management and production techniques (Feder, 1983).

Export expansion increases productivity by creating scale economies (Krugman, 1998)

Exports help to alleviate foreign exchange constraints and thus provide greater access to international markets (Esfahani, 1991).

Endogenous growth theory extends this analysis by emphasizing the role of exports on technological innovation and dynamic learning (Romer, 1986, Lucas, 1988).


Empirical evidence in the last few decades indicates that FDI flows have been growing at a pace far exceeding the volume of international trade. Between 1975 and 1995, the aggregate stock of FDI rose from 4.5% to 9.7% of world GDP, with sales of foreign affiliates of multinational enterprises substantially exceeding the value of world exports (Ray and Nigel, 1997).

Sachs et al. (1995a) looked at the relationship between openness and economic growth for a sample of more than 100 countries from 1970 – 1990. Their results showed a strong association between openness and growth both within the group of developing and the group of developed countries. Within the group of developing countries, the open economies grew at 4.49% per year and closed economies grew at 0.69% per year. Within the group of developed economies, the open economies grew at 2.29% per year and the closed economies grew at 0.47% per year.

However, empirical work from both the ELG literature and the FDI and growth literature when studied in isolation show mixed results. This is mainly, due to the omission of a relevant mechanism through which openness or the re-structuring of an economy promotes growth. Liberalization, in particular, is expected to increase not only trade but also FDI. If a complementary relationship between FDI and exports exists, then foreign investment may increase the volume of exports in specific and international trade in general. Direct investment may encourage export promotion, import substitution, or greater trade in intermediate inputs, especially between parent and affiliate producers (Goldberg and Klein, 1997).

Along the same lines, Blomstrom et al (2000) argue that the beneficial impact of FDI is only enhanced in an environment characterized by an open trade and investment regime and macroeconomic stability. In this environment, FDI can play a key role in improving the capacity of the host country to respond to the opportunities offered by global economic integration. In the absence of such an environment, FDI may impede rather than promote growth by enhancing the private rate of return to investment for foreign firms while exerting little impact on social rates of return in the recipient economy (Balasubramanyam et al., 1996).

Early studies supporting the ELG hypothesis such as those by Balassa (1978) and Tyler (1981) examined the simple correlation coefficient between export growth and economic growth, and based their conclusions based upon the high degree of correlation between the two variables. Other studies, characterized by Feder (1983), Balassa (1985), Ram (1987) and Ukpolo (1994) find support for ELG based upon growth and output regressions drawn from a growth accounting framework. Ogbekor (2005) examined the role of exports and FDI on the growth of Namibian economy from 1991 to 2001 and his study concludes that FDI and export aids in economic growth potential. In summary,

Open Economy ⇒↑Efficiency ⇒↑Output ⇒↑ Income Level (Economic Growth)

(Free Trade) (Standard of Living) HUMAN CAPITAL


Human resource development (HRD) and FDI has been opined to be among key drivers of growth in developed and developing countries (Borensztein et al., 1998, Mankiw et al., 1992). While HRD and FDI individually affect growth, they also reinforce each other through complementary effects (Miyamoto, 2008). In general, enhanced HRD increases incoming FDI by making the investment climate attractive for foreign investors. This is done through a direct effect of upgraded skill level of the workforce, as well as via indirect effects such as improved socio-political stability and health (UNESCO and OECD, 2003, WORLD BANK, 2003).

On the other hand, FDI contributes to HRD since multinational enterprises (MNEs) themselves can be active providers of education and training, bringing new skills, information and technology to host developing countries. Ultimately, this complementary effect leads to a virtuous circle of HRD and FDI where host countries experience continuous inflow of FDI over time by increasingly attracting higher value-added MNEs, while at the same time upgrading the skill contents of pre-existing MNEs and domestic enterprises. This argument is in line with Borensztein et al. (1998) argument that FDI has a positive effect when the country has a highly educated workforce that allows it to exploit FDI spillover.

The literature on human capital and FDI indicates that human capital is an important determinant of FDI, especially among efficiency-seeking FDI which requires a skilled workforce as one of its key inputs. Although higher human capital does not appear to affect inflows of resource/market-seeking FDI directly, it can indirectly affect FDI by improving civil liberties, health and crime rates (Miyamoto, 2008)


Preliminary studies by World Business Environment Survey, Foreign Direct Investment Survey organized by the World Bank and other bodies in the year 2000, show that the quality of human resource is an important criteria for MNEs investment decision and the ability to hire technical/managerial staff and skilled workers are among critical factors of location choice.

In a study of 69 developing countries over the last two decades, Borensztein et al. (1998) finds a strong positive interaction between FDI and the level of human capital showing that the effect of FDI on economic growth is dependent on the level of human capital available in the host economy. Notably, the same interaction was not found to be significant in the case of domestic investment, possibly a reflection of differences of technological nature between FDI and domestic investment.

↑Enhanced HRD ⇒↑Highly Skilled Workforce ⇒↑ FDI

A countries ability to take advantage of FDI has been shown to be limited to the “absorptive capacity” i.e. local conditions such as development of local financial market or educational level (human capital) of the country (Borensztein et al., 1998). In contributing to this, Alfaro et al (2004) and Durham (2004) provide evidence that only countries with well-developed financial markets gain significantly from FDI. Two key points of Alfaro’s research are that financially developed countries experience higher growth rates from increased FDI and local conditions such as development of financial markets and educational level of the country affect the impact of FDI on growth.

Industry and country level studies find positive impacts of FDI on economic growth. For example, a positive relationship was found for Uganda (Obwona, 2004), Uruguyan manufacturing industries (Kokko et al., 1996), China (Chen et al., 1995 cited in Ajayi, 2006) and for labour productivity in Brazil (Bielschowsky, 1994 cited in Mello, 1997).

In summary, both theoretical and empirical review of literature on FDI and economic growth has pointed implicitly and explicitly to the fact that human capital, knowledge and technology, spillovers and trade openness does have impact on FDI and economic growth. The review has further showed the transmission mechanism through which this effect occurs thereby answering one of the research questions.

Chapter Four

Background to the Case Study

4.1 Introduction

Nigeria is Africa’s most populous country with about 140 million inhabitants. However, approximately 55% of the population lives on less than the value of one US dollar per day (Datamonitor, 2007). Nigeria may be the most challenging and important development country in the world today. It is by far the world’s most populous extremely poor country – but is the sixth largest oil exporter. It has the smallest manufacturing sector of any large economy in the world, and the greatest concentration of export and government revenue dependence on a natural resource commodity. It has witnessed spectacularly failed economic policies with GDP no higher than it was forty years ago.

Nigeria’s has several social problems some of which are due to the oil and gas exploration in the country – with half of the adult population illiterate, gender disparities in education and access to water and social amenities like good road being limited. The rising and ongoing militant violence in the Niger delta region of the country due to oil exploration is one which has been a major challenge for the government of the country. It is rated as one of the world’s most corrupt country.

So much of positive and negative issues in Nigeria have been tied to the oil and gas sector and it has become evident that there is need to study the relationship between investment in this sector and the growth of the country.

This section shall seek to provide an analysis of the case study - Nigeria, providing an overview of its pol

To export a reference to this article please select a referencing stye below:

Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.

Request Removal

If you are the original writer of this dissertation and no longer wish to have the dissertation published on the UK Essays website then please click on the link below to request removal:

More from UK Essays

Get help with your dissertation
Find out more