ECA - CEAECA - CEAInvestment Climate & Foreign

Direct Investment in Africa

Emmanuel Nnadozie, Director, EDND &

Angelica Njuguna, Economic Consultant

United Nations Economic Commission for Africa

Addis Ababa, Ethiopia

6th African Economic Conference 25-28 October 2011

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Outline of Presentation

1. Introduction2. Patterns and Trends of FDI in Africa3. Investment Climate & FDI4. Business Environment & Doing

Business Africa5. Empirical Model, Data, & Results6. Conclusions & Policy

Recommendations

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Introduction

The role of FDI:

- Providers of technology; management expertise; link to external market; employment; and finance for development

- May lead to structural transformation & rapid economic development. E.g. Japan & NICs

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Introduction

Developed countries are the preferred destination of FDI

Over 50 % of world’s shares go to developed countries

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World’s FDI Inflows, 2009

Developing economies: America

11%

Developing economies: Asia

29%

Developing economies: Africa

6%

Developed economies54%

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Introduction

Distribution of FDI inflows among the developing countries are uneven.

- FDI in Africa remains small and lowest

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Distribution of FDI, Developing Regions, 1970-2009

1970s 1980s 1990s 2001-2005

2006 2007 20082009

0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

400.00$ Bn

Developing economies: Africa Developing economies: America Developing economies: Asia

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FDI in Africa

Concentrated in few countries mostly with natural resources

60 % go to 5 countries (Angola, Egypt,

South Africa, Nigeria & Libya) 79 % go to 10 countries 92 % go to 20 countries 8 % go to remaining 33 countries

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Top 10 countries main FDI destination Belong to middle income countries Main FDI to 6 countries is in mining &

quarrying (oil/hydrocarbon sector) Main exports of these 6 countries are

petroleum & petroleum products ranging from 47 % to 97 % of total exports

However, Egypt, South Africa, Morocco & Tunisia’s exports are more diversified to other sectors.

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Policy Questions

If the main driver of FDI in Africa is the natural resource endowment.

What is the chance of a poor, less-endowned African country to attract FDI?

What do African governments do to obtain more FDI if it is believed to help in economic development?

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Investment Climate & FDI

A growing consensus in literature believed that domestic “investment climate” matters to attact FDI.

Investment Climate refers: Foreign investment regime General investment environment

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Investment Climate & FDI

Different studies used broad indicators to describe investment climate (sound economic & political conditions, infrastructure, financial development, etc.)

However, the consensus is: investment climate constraints negatively influence FDI inflows.

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Reforms & business environment

African economists & policy makers believe in a friendly business environment E.g. Uganda attacks FDI due to its

predictable investment climate Governments institute reforms to

improve their business environment: reduce taxation; privatization; governance reforms (APRM); stabilization of macroeconomic environment

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Business Regulations & Ease of doing Business

Fundamental premise of “doing business” is that economic activity requires good rules

In 2003, the World Bank introduced ranking of countries according to the “ease of doing business” index.

*Index indicates that the lower its value the easier it is to do a business in a particular country.

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Which indicators make up the ranking?

• Starting a business: – procedure, time, cost and paid-in minimum

capital to open a new business

• Dealing with construction permits: – procedures, time and cost to obtain

construction permits, inspections and utility connections

• Employing workers: – Difficulty of hiring index, rigidity of hours index,

difficulty of redundancy index, redundancy cost

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Which indicators make up the ranking?

• Registering property:– Procedures, time and cost to transfer

commercial real estate

• Getting credit– Strength of legal rights index, depth of credit

info index

• Protecting investors– Strength of investor protection index: extent

of disclosure index, extent of director liability index and ease of share holder suits index

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Which indicators make up the ranking?• Paying taxes

– Number of tax payments, time to prepare and file tax returns and to pay taxes, total taxes as a share of profit before all taxes borne

• Trading across borders– Documents, time and cost to export and import

• Enforcing contracts– Procedures, time and cost to resolve a

commercial dispute

• Closing a business– Recovery rate in bankruptcy

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Ease of doing business ranking

Region Ave. RankingOECD 30East Asia & Pacific 83Middle East & N Africa 92Latin America & Caribbean95South Asia 118Sub-Saharan Africa 139

Source: WB 2010

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Doing Business in 20 most favored-FDI countries 14/20 countries favorite FDI

destinations have rank better than 139 (African average).

South Africa, Namibia, Tunisia, Zambia & Ghana made it to top 100 countries (out of 183)

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Doing Business in 20 most favored-FDI countries

Doing business is easier compared to average African country, in many stages of business life cycle:- starting a business takes less

days/procedures- registration of properties takes less

days/procedures- Easier access to credit- Trading across border is cheaper- Lower taxes- Higher recovery rate of investments

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Why is it important to do this study?

1. There is a perception that FDI in Africa is mainly driven by natural resource endowment.

2. Since natural resource endowment is exogenous variable, resource-poor countries have small chance to attract FDI.

3. FDIs in extracting industries have limited linkages to other sector of the economy.

4. Reforms to improve business environment/regulations is a costly exercise and therefore, is it really worth it?

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Empirical Model

Theoretical framework was based on the behavior of a rational economic agent, where firm’s main objective is to maximize profit i.e. Foreign investors invest in another

country due to profit or return to investment, which is a function of total cost and quantity produced.

minimizing total cost of doing business or maximizing profit for FDI looks for favorable investment climate.

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Empirical Model

FDI = F (policy variables, economic variables,

governance/political variables,

others e.g. structural variables)

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Data

• Two sets of data from World Bank(1)CPIA = country policy and institutional

assessments * Macroeconomic ratings* Transparency ratings* Business ratings

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Data

(2) Ease of doing Business Index – average of country’s rankings on the 10 topics presented earlier. This is to represent business reforms/regulations.

– plus: population, oil production dummy

education inflation, GDP per capita openness transparency index

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Regression Results using CPIA DataDependent variable: FDI

Variable Regression 1: Coefficients Regression 2: Coefficients

Constant

Business Rating

Macro Rating

Tranparency Rating

Oil_production Dummy

GDP

-463.09(-9.01) ***

69.43(6.91) ***

76.81(6.95) ***

51.73(2.86) ***

653.21(13.53) ***

..

-46.35(-1.82) *

11.42(2.02) **

-14.01(-3.06) ***

11.76(0.78)231.41

(4.08) ***0.06

(12.67) ***

Adj R2

N = 38 countriesTotal panel = 152

observations

0.14 0.53

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Panel data estimation with Ease of doing Business Index

Dependent variable: FDI

Variable Regression 1:Coefficients

Regression 2:Coefficients

Constant

Ease of doing business

Inflation

Population

Openness

Oil_dummy

Transparency ratings

275.02(1.31)-2.71

(-2.45)**-33.78

(-4.69)***31.03

(8.56)***1.39

(1.68)*845.25

(3.87)***..

-195.16(-0.49)-4.06

(-2.71)***-45.61

(-3.78)***27.54

(6.36)***3.50

(1.94)*361.06(1.58)*207.33

(2.74)***

Adj R2

No of countriesTotal panel obs.

0.613570

0.752550

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Conclusions & Policy Implications

• Reiterate that structural, economic, political and policy variables matter

• Business reforms & regulations matters• Countries in Africa that are not endowed

with abundant natural resources can still attract FDI

• African countries should not only improve economic and political for business but also on policies and business reforms and regulations.

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Thank you