The role of FDI in trade and wealth creation in Africa

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Many African countries have initiated economic reforms aimed at increasing the role of the private sector through the privatisation of State-Owned Enterprises (SOEs), deregulation of the business environment and the protection of Intellectual property rights to encourage Foreign Direct Investment (FDI) into the continent to boost trade and wealth creation.

However, the flow of FDI to the continent has been slow. African governments have realised this and have attributed this state of affairs to the negative image of Africa as a whole. They are, therefore, of the view that it may not be sufficient to improve the investment climate alone but must also establish investment promotion centres and platforms and create conditions/policies for attracting investment to the continent.

Hence, this research paper seeks to analyse the role of FDI in trade and wealth creation in Africa, using South Africa and Botswana as case studies. South Africa and Botswana are being used in the study as a result of the quantum of FDI they have received over the years. This effort will also be supported by examples drawn from other African countries like Morocco, Mozambique, Namibia, Lesotho, Ghana, etc.

Foreign Direct Investment (FDI) is welcomed and, indeed, actively sought by all African countries. The contribution FDI can make to economic development and to the integration of countries into the world economy for trade and wealth creation has been recognised. Over the past decades, African countries have made considerable efforts to improve their investment climate. They have liberalised their investment regulations/policies and have offered incentives to foreign investors.

The economic performance of the region has substantially improved from the mid- 1990s till the present day, 2022. Yet, the surge in FDI has not occurred as much as was expected. Many African countries, especially the least developed ones, continue to be ignored by investors. Too often, potential investors discount the African continent as an alternative location for investment because of the negative image of the region as a whole and concealed the complex diversity of economic performance and the existence of investment opportunities. The final outcome is that the region has partly been marginalised in worldwide flows, stocks of FDI and wealth creation (UNCTAD 1998).

Despite the gloomy past, indications are that the stock of FDI investment in Africa has been rising slowly between 1980 and 2000 and continues till this day – where Chinese Investments have increased tremendously on the continent.

Before this current era of the 2020s, FDI inflows gained momentum in the second half of the 1990s and after increasing to a record $10.5 billion in 1999 but declining to $9.1 billion in 2000. This was attributed to the recession in the United States economy during the 2000s, which was the biggest source of FDI to Africa. However, these volumes represent a significant increase relative to flows that average $3 billion per annum at the beginning of the 1990s ( UNCTAD 1998).

Notwithstanding the increase in the absolute stock of FDI over the period 1980-2000, Africa’s share of global stock has declined from about 5.3% in 1980 to about 2.3% in 2000 and further in these Covid-19 times. In other words, although there has been an increase in the volume of FDI flow to Africa, they have not kept pace with flows to other regions of the world.

That being said, it is important to note that some African countries have made steady progress in attracting FDI to the region. Thus, out of 34 least developed countries, the share of total FDI inflows to Africa increased from 22% between 1989-1994 to about 43% in 2000 and further into the 2020s.

But, looking back, a joint survey by the United Nations Conference on Trade and Development (UNCTAD) and International Chamber of Commerce Report in 1999/2000 indicated that, of the 296 world’s largest multi-national corporations at the World Economic Forum in 1998, it was suggested that, Mozambique, Tanzania, South Africa, Uganda, Botswana, Morocco, Ghana, Namibia and Nigeria were the most likely countries in Africa to attract Foreign Direct Investment (FDI). And this trend has continued till this day.

However, it is important to mention that the continuing and uncertain effects of the COVID-19 pandemic have clouded the outlook for FDI in Africa. Greenfield announcements point out that FDI fell by 62% to $29 billion in 2020 from $77 billion in 2019, and international project finance for large infrastructure projects fell by 74% to $32 billion. This perhaps indicates that FDI flows into Africa after the pandemic may drastically be reduced or would have to pick up quickly to make up for the existing shortfalls.

That being said, this paper seeks to explain or explore if, indeed, FDI has significantly contributed to the wealth of nations and has been keen in determining world trade. The analysis is being confined to two case studies – South Africa and Botswana for the added reason of variability or lack of adequate data for all African nations. This is critical to the authenticity and consistency in the research analysis for this paper.

An attempt will be made to cite examples from other African countries which have in diverse ways attracted appreciable levels of FDI, like Morocco, Namibia, Tanzania and Uganda, Ghana, etc., and have also implemented economic reform programs to allow the flow of FDI into their economies.

Thus, the paper is organised by way of an abstract, a general introduction, a definition of FDI, reasons for FDI or why FDI may not flow into a country, followed by country analysis of FDI and conclusions.

Rutherford (1995) defines FDI as an investment in businesses of another country, which often takes the form of setting up local production facilities or the purchase of existing businesses or enterprises. Vickers (2002) defines FDI as the acquisition or the creation of assets in a foreign country. Usually, investors possess a controlling stake and have a long-term interest in the investment. FDI takes three forms, namely Greenfield investment, Cross border merger and acquisition and Brownfield Investment.

Foreign Direct Investment decisions:

According to Muff (2002) firms wanting to undertake FDI abroad are faced with three decisions.

1. Whether to invest abroad
2. Where to invest
3. How to invest

Why or Importance of FDI to Africa:

(a) Africa like many other regions in the world need a substantial inflow of external resources in order to fill the savings and foreign exchange gaps associated with the rapid rate of capital accumulation and growth which is needed to overcome widespread poverty and improve living standards to acceptable levels (Africa Resource Center Inc. 2000).

(b) FDI generates thousands of jobs in the host economies of Africa.

(c) FDI is a vehicle for the transfer of Technology.

(d) FDI provides superior skills and management techniques for host African countries.

(e) It facilitates the process of capital formation.

(f) FDl uses local resources more efficiently and productively.

(g) It also increases product diversity.

It is also important to note that, FDI has negative effects on Africa:

1. FDl could lead to the dumping of foreign goods on domestic markets making it difficult for local businesses to survive.

2. Multi-National Corporations are powerful, have enough revenue or capital resources and can dictate to African governments.

3. Some FDIs are natural resources based. They tap heavily in-replenishable natural resources such as diamond, gold, oil, coltan, bauxite, copper, etc, which leaves the environment very degraded. For example, gold mining in Ghana and South Africa has destroyed rivers, streams, farmlands, forests and communities. Hence there have been calls for environmental impact assessment studies for environmental-related projects.

(4) Repatriation of earnings from the host country does not help develop the domestic economy.

(5) Balance of payments problems, coupled with MNCs influencing interest rates and monetary policies in their favor may not be favorable to host countries.

Country Analysis:

South Africa:

South Africa is said to be the biggest recipient of FDI in Africa and its share of the continent’s FDI stands at 50% in 2000 (The Global Competitiveness Report 2000) and remains so to this day.

The reasons for South Africa being the leading recipient of FDI in Africa are as follows:

1. Legislative changes: Since the African National Congress (ANC) came into power, there has been over 500 legislative changes affecting businesses in South Africa (CDE, 2001).

2. Economic Policy: The South African government’s economic policy aims at improving the investment climate and credentials in order to attract higher levels of long-term FDI inflows for the purposes of solid and sustainable economic growth and development (Vickers, 2002).

Market Size: ( Location Advantage): in mid-2002 the average population for South Africa was 44.4 million with an average growth rate of 2.0% (1990 to 2000). However, it is widely believed that the country’s HIV/AIDS pandemic will slow down population growth rates and also affect fertility rates. This was a serious problem confronting the government at the time, and there were also concerns in the business community and FDI. In spite of this, South Africa was and is a middle-income country with an estimated GNP per capita of $3170 which was far above many African countries and remains so in 2022.

Nonetheless, it is important to note that, the inflow of foreign capital are partly offset by outward investments by South African companies trying to expand their activities in foreign markets. For example, the share of South African investment – both private and public in total in the 14-member South African Development Community (SADC) was significant and accounted for about 47% of deals made in the region.

The expectation of net outflow of FDI from South Africa in 1997, 2000, and 2022 may be attributed to the following reasons.

In, 1997 the government completed its first partial privatisation transactions involving foreign participation. This represented 30% of equity interest in the national telecommunication operator Telkom, which was constituted by a consortium of non – residential companies in the United States and Malaysia.

In 2000, FDI inflows in South Africa resulted from the acquisition of private sector companies by non-resident investors and the restructuring of government assets, more specifically the selling of 20% equity interest in South Africa Airways (SAA) to Swissair.

In the second half of 2001, South Africa recorded a net capital inflow of Rand 1.6 billion. Thus, the restructuring of the corporate relationships between the Anglo American Corporation and De Beers mining company led to a reduction in offshore assets or inflow of capital. This was because Anglo American Corporation was now based in London when it bought out De Beers. The outcome appeared as a sustainable increase in FDI and an apparent reparation of capital by a South African company. In the long run, this transaction seems likely to aggravate the outflow of resources in the form of payment of profits and dividends abroad by De Beers.

In the sectoral distribution of FDI in South Africa in 2000, 2020, food, beverages and tobacco were top investment sectors, followed by motor and components, partly as a result of the consolidations and reinvestment by car manufacturers and convertible facilities. But with the on set of Covid-19 in 2020, attention was shifted to medical research and medical supplies to combat the pandemic.

However, factors like small market size, uncertainty or confidence factors, high crime wave, skill shortages, high production cost, labor regulations, poor economic growth, regulatory uncertainties, poor domestic business confidence, racial tensions, Covid-19 management, and investment policies were some of the major challenges facing the South African economy. Indeed, these factors were responsible for the lack of FDI inflows into the country resulting in low levels of trade and wealth creation.

Botswana:

Its natural resources endowment comprises mainly of diamonds in the Kalahari desert, copper deposits at Selebi-Phikwe and local soda ash. The mining sector accounted for 50% of total revenue from mineral taxes. Royalties also represented more than 50% of total revenue intake and diamond exports stood for almost 75% of total exports.

The slump in world market prices between 1993 – 1994 led to a fall in export earnings, reduced government revenue, poor economic growth and wealth creation. For this reason, the government of Botswana focused efforts on the diversification of the economy and took broad steps to change the production base by encouraging more diversified FDI.

In this regard, Botswana succeeded in attracting investment in manufacturing linked to the mining sector. For example, the private sector showed considerable interest in cutting and polishing diamonds. The single biggest firm to arrive from the United States – Lazare Kaplan International formed a joint venture with the government for a 15% share.

Botswana has also succeeded in attracting export-oriented foreign direct investment in textiles mainly from Malaysia, South Africa and Zimbabwe and auto assembly of Volvo from semi-knocked down (Skd Kit) and Beef industries (Basu and Srinivasan 2002).

According to Corporate Location (1994) Volvo established an Assembly Plant in Botswana to cater primarily for the South African market and but also to tap into the emerging car markets of neighboring Namibia and the Democratic Republic of Congo.

All these policies have been possible because of the political stability, strong macroeconomic fundamentals, good governance and low levels of corruption, investment in human and physical capital, low-cost labour and low tax rates.

That being said, markets in Botswana are still small and not expanding fast to attract more foreign direct investment into the region. There is still a sizable amount of the population who are uneducated and are not semi-skilled. In addition to this, there is the need for more infrastructure development, and improvement in telecommunications to help attract more FDI into the country. There is also a high incidence of AIDS, which has been threatening the population. But new and effective medicines discovered over recent years is helping to alleviate the problem. However, at one time or the other this was a serious problem for the government and business community because of cultural considerations and poor acceptance of orthodox medicines to reduce the incidence of the disease.

Nonetheless, it is critical to stress that multiparty democracy and efficient functioning of political institutions have allowed for good governance and has contributed toward transparency and accountability in the operations of government and investment projects. It has been argued that one of the reasons why Hyundai decided in 1993 to establish its car assembly plant in Botswana, to serve the South African market was mainly due to good governance and political stability (Corporate Location 1994).

Conclusion:

While Africa is undoubtedly a region in which natural resources abound, it is clear from the above analysis that, a critical mass of mutually reinforcing measures needs to be in place before countries in Africa can secure a larger share in global FDI flows, wealth and greater share of world trade. Progress towards conflict resolution is essential because an important determinant of investment location is political stability.

Further, it is possible to argue that, South Africa, Botswana and other African countries were able to attract reasonably large amounts of FDI only after some measure of political stability was established. Political stability however is a necessary, but not a sufficient condition to ensure access to large FDI flows, wealth creation and trade.

Within Africa, and in other regions of the world, political stability has been key to attracting FDI. African countries that have sought to contain inflation and stabilise the exchange rate, through the adoption of sound fiscal and monetary policies have fostered growth, stimulated wider participation of the private sector in economic activity have secured significant amounts of FDI and contributed significantly to wealth creation and world trade ( Pigato et al 2000).

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