Foreign direct investment in Africa : the role of the financial system / Wynand Smit
Africa remains the poorest continent despite being one of the most richly endowed regions of the world. With a per capita income of only US$ 300, four out of every 10 Africans live in extreme poverty on less than US $1 per day. In terms of capital inflow, Africa receives very low levels FDI inflows and its share of total FDI flows has risen by less than one percentage point during the last decade. The positive impacts of FDI have been studied and empirically proven over the last few years. Economic growth and the expansion of productive capacities are positive results associated with FDI, yet the effective attraction and absorption of FDI is a necessary prerequisite. It is in this context that the financial systems of African countries are evaluated. The first objective of this study was to create a theoretical understanding vis-a-vis FDI by studying the different determinants, advantages, disadvantages and prerequisites for successful FDI absorption. From the literature it was found that FDI can bring two broad kinds of substantial economic benefits namely economic growth and the expansion of productive capacities. The second objective was to determine, the functioning, composition and elements of the financial system as the financial system plays an important role in the abortion of FDI and converting it into the identified two economic benefits. Two primary types of financial systems were identified namely: a bank- and a market based financial system. The third objective was to analyze current global and African FDI, economic growth and financial system trends. It was found that Africa is receiving very low levels of FDI relative to the rest of the world and that Africa's economic growth are not in tandem with the increasing levels of FDI flows to the African continent. This raised the question of effective FDI absorption in Africa which led to the identification of different financial system variables which spurred the empirical investigation. The last objective and main aim of the study was to answer the following three research questions: (i) what are the elements (if any) of Africa's financial system that deter FDI inflows to the continent, (ii) how effective is the abortion of FDI in Africa and which elements of the financial system are able to absorb FDI effectively and (iii) do FDI inflows and the financial system absorption capacity significantly affect economic growth on the continent? Data of 26 African countries from 1980 to 2002 were used to attain an African perspective on the relationship between FDI, the financial system and GDP growth. The results indicate that various financial system variables do indeed have a positive influence on the attraction of FDI towards African countries. There was also some evidence of a balance between bank and market related variables which imply that developing a balanced financial system can contribute to FDI inflows in Africa. With only 12 active equity markets on the continent, the implication of this crisis an area for development. The results also indicated that a more market-based financial system does better in absorbing FDI in the economy, maximizing the economic benefit. It can thus be concluded that even though FDI is an important source of potential growth, Africa's absorptive capacity is not developed thoroughly enough to convert FDI flows into economic growth. While Africa's financial system is not a deterrent to attracting FDI towards the continent, it is unable to utilize this optimally towards the advantage of its people. This inability to absorb FDI is a very important question as it holds a potential solution for Africa's high levels of poverty and underdevelopment.
- ETD@PUK