Each country of the world tries to attract foreign direct investment (FDI) because it is a great source of external finance.
FDI makes it possible for countries with less capital to get finance from richer countries. Several experts considers that FDI has a positive impact and accelerate the economic growth process of developing countries (Obiwona, 2001). A lot of benefits are related with the inflow of FDI among which are the opportunity it provides developing countries to have access to modern technology and important administrative skills which are capable of creating more jobs, increasing domestic output, increasing wages and standard of living and lowering cost of production, among others (Cohen, 2007).
Moreover, FDI has been possibly one of the ways through which external capital is sourced to increase domestic savings in developing countries owing to the inadequacy of their capital and financial market to finance the different sectors of the economy (Adeoye, 2009). Furthermore, FDI is also helpful for developing economies to access the foreign markets on behalf of its people (Obiwona, 2001). So, the advocates of FDI considers that it has a positive effect on the recipients economy through the supply of capital, technology and management resources that are not available in the host country along with creating new jobs (Hill, 2003). It is therefore clear that FDI is vital in a country to bridge technological gap, resources gaps, revenue-expenditure gap, saving-investment gap, and export/output gap, among others. These benefits of FDI mentioned above, are essential for sustainable economic growth in developing countries.
To attract FDI, a country is dependent on many factors which include: human capital, labor costs, FDI policy, market size, infrastructure and profitability expectation, among others. Several studies have recognized infrastructure as the main source of FDI inflow. For instance, Chakrabarti et al (2012) found a positive relationship between FDI inflow and infrastructure. Similarly, Hakro (2011) and Omezzine (2011) observed that governance infrastructure had a significant effect on FDI flows.
The capability of infrastructure to promote FDI is assigned to the fact that it creates a profitable climate for foreign investors to assign their funds in the host country. Multinationals can be seen as profit-seeking entities which search to minimize the costs of doing business and any insufficient infrastructure or unavailability of public inputs will lead to an increase in costs. As such, infrastructure should make the investment climate for FDI better by subsidizing the cost of the total investment by foreign investors and as a result increasing the rate of return (Khadaroo and Seetanah, 2008). Seetanah (2009) also asserted that gains which results from infrastructural development are closely related with greater accessibility and a reduction in the transportation costs. In addition, he claimed that the presence of public goods decreases the cost of doing business for a foreign company and thus raising its returns or profits considerably. Other studies also stated that the presence of public goods plays an important role in deciding the structure of cost and productivity of firms which are operating in the private sector (Bénassy-Quéré et al, 2007). Furthermore, Erenberg (1993) concludes in his study as well that public infrastructure decreases the cost of transportation.
If we take a look at the literature on developing countries, only a small amount relates to Africa. The variety of studies that deals with the determinants for FDI in Africa is limited, however
The number of studies that is about the determinants for FDI in Africa is limited, but most of them include infrastructure as one of the variables. Several of them found a positive correlation, but a considerable number of others did not find a significant relationship. Hence, the results on the relationship between infrastructure and FDI are rather mixed. This also follows from studies about FDI determinants in other continents. Although it might be expected that foreign investors prefer locations with a high level of infrastructure more, there is no straight-forward evidence in the academic literature that this factor significantly impacts their location decision. What makes it even more relevant to analyse this relationship in Africa, is that the papers specifically aimed at clarifying the effect of infrastructure on FDI in (a part of) Africa are just those of Khadaroo and Seetanah (2009 and 2010). Also, to my best knowledge, the only paper that included a wide variety of infrastructure indicators is the one from Fedderke and Bogetic (2009). However, it examines the relationship with economic growth instead of FDI. The authors found a significant positive relationship, meaning that there might not only be an indirect effect of infrastructure on growth (via FDI), but also a direct effect. Furthermore, this study is one of the few that addresses the problem of reverse causality regarding the effect of infrastructure. When studying the effect of infrastructure on FDI this endogeneity should be accounted for, because otherwise the effect cannot be estimated accurately. Hence, there is ample room for enrichment of the present literature on this topic.
Apart from filling an apparent gap in the academic literature, there is another reason why it is important to study infrastructure as one of the possible determinants of FDI in Africa. From all developing countries, African countries have attracted the smallest amount of FDI during each year in the period 1990-2015, as is indicated by figure 1. Moreover, many countries in this continent are very poor. By attracting more FDI, poverty in these countries can be reduced. Hence, if infrastructure appears to attract FDI, investing in this factor could help to eradicate poverty in Africa. There are various prestigious organisations that underscore the importance of good infrastructure in Africa. According to the World Bank, a sufficient level of infrastructure is one of the components of a favourable investment climate for foreign as well as domestic investors (Farole and Winkler, 2013). However, it has declared that ‘across Sub-Saharan Africa, poor infrastructure is a major bottleneck for sustainable development’ (World Bank, 2014, p. 1). Also, the results from EY’s 2015 Africa attractiveness survey showed that ‘poor basic infrastructure’ is the fourth most prominent barrier according to foreign investors, behind unstable ‘political environment’, ‘corruption’ and ‘weak security’ (EY, 2015). On top of that, KPMG identifies infrastructure as a stimulator for FDI inflow in Africa (KPMG, 2016). Hence, as it seems that a higher level of infrastructure may attract FDI, it is relevant to analyze this relationship empirically.
In this thesis, I will deliberately analyze all countries in Africa, so not only Sub-Saharan countries, the latter being more common in the academic literature. It may be useful not to include developing countries from other continents, given that, at least according to Asiedu (2006), many African policymakers consider Africa to be structurally different from the rest of the world. Therefore, they would probably regard the results of the analysis in this thesis as more credible. There are many determinants for FDI inflow, which will be controlled for in the empirical models, but the focus will be on the effect of infrastructure on FDI. This leads to the following research question:
“What is the effect of infrastructure on foreign direct investment in Africa?”
In order to be able to answer this question, three types of infrastructure will be analysed, namely transport infrastructure, communication infrastructure, and electricity supply. This distinction is necessary because these categories are rather different by definition, for which it is not unlikely that their relationships with FDI differ. Moreover, such a distinction makes it possible to test whether a common indicator for infrastructure, being the number of telephone lines per 1000 inhabitants, is representative.
a lot of previous studies reviewed have used telephones lines as a proxy for infrastructure, which is not fully representative of all facets of infrastructure
should the relationship between infrastructure development and FDI exist, and also between FDI and economic growth, policy makers in developing countries can perhaps use infrastructure as a tool to attract FDI and thereby increase economic growth.
The aim of the paper is thus to investigate the empirical link between transport infrastructure and FDI for the case a panel of 30 Sub Saharan African countries, selected as per data availability, for the period 1984-2002 using panel data regression techniques.
The present study contributes to the existing literature by empirically examining the behavior of FDI mainly to infrastructure along with market size and exchange rate effects in Pakistan
Among many studies, Veganzones (2004) and Asiedu (2006) are two studies who used telephone lines as proxy for infrastructure. We expect positive sign of coefficient for infrastructure.
This paper is organized as follows. While, in section 2, the literature is reviewed, section 3
presents the data and methodology. Section 4 discusses estimation results. Finally, some
concluding remarks are examined in Section 5.