CHAPTER ONE INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Foreign Direct Investment (FDI) which is an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor, has long been a subject of great interest in the field of international development. In an era of volatile flows of global capital, the stability of FDI and its emergence as an important source of foreign capital for developing economies has once again renewed interest in its linkages with sustainable economic growth. FDI inflows contributed to a strengthening of the balance of payments in several African countries. In 2006, foreign reserves in the region as a whole grew by 30%, and by even more in some major oil-exporting countries such as Nigeria and the Libyan Arab Jamahiriya (World Investment Report, 2007). Indeed, for developing countries taken as a group, net inflows of FDI have increased almost five fold from an average of 0.44% of GNP in the period 1970-74 to 2.18% of GNP in the period 1993-97 (World Bank, 1999). FDI now forms a significant component of domestic investment activity in developing countries accounting for more than 8% of Gross Domestic Investment (GDI) in the mid-1990s up from 2% of GDI in the early 1970s. Finally, FDI is now the pre-eminent source of capital flows into developing countries accounting for about 36% of total capital flows in the mid-1990s up from approximately 18% of flows in the 1970-74 period (World Bank, 1999). Average annual inflows of Foreign Direct Investment (FDI) into Africa doubled in the 1980s compared with the 1970s. It also increased significantly in the 1990s and in the period 2000-2018. Comparisons with global flows and those of other regions may be more useful, however. In the mid 1970s, Africa’s share of global FDI was about 6%, a level that fell to the current 2–3%. Among developing countries, Africa’s share of FDI in 1976 was about 28%; it is now less than 9% (United Nations Conference on Trade and Development – UNCTAD, 2005). Also in comparison with all other developing regions, Africa has remained aid dependent, with FDI lagging behind Official Development Assistance (ODA). Between 1970 and 2018, FDI accounted for just one-fifth of all capital flows to Africa. It is well known that FDI is one of the most dynamic international resource flows to
developing countries. FDI is particularly important because it is a package of tangible and intangible assets and because firms deploying them are important players in the global economy. There is considerable evidence that FDI can affect growth and development by complementing domestic investment and by facilitating trade and transfer of knowledge and technology (Holger and Greenaway, 2004). The importance of FDI is envisioned in the New Partnership for Africa’s Development (NEPAD), as it is perceived to be a key resource for the translation of NEPAD’s vision of growth and development into reality. This is because Africa, like many other developing regions of the world, needs a substantial inflow of external resources in order to fill the saving and foreign exchange gaps and leapfrog itself to sustainable growth levels in order to eliminate its current pervasive poverty (Ajayi, 1999, 2000, 2003).
The literature on the FDI–growth relationship is vast for both developed and developing countries. The basis for most of the empirical work focuses on neoclassical and endogenous growth models. It is often claimed that FDI is an important source of capital, that it complements domestic investment, creates new jobs opportunities and is in most cases, related to the enhancement of technology transfer, which of course boosts economic growth. While the positive FDI–growth linkage is not unambiguously accepted, macroeconomic studies nevertheless support a positive role for FDI especially in particular environments. Existing literature identifies three main channels through which FDI can bring about economic growth. The first is through the release it affords from the binding constraint on domestic savings. In this case, Foreign Direct Investment augments domestic savings in the process of capital accumulation. Second, FDI is the main conduit through which technology transfer takes place. The transfer of technology and technological spillover lead to an increase in factor productivity and efficiency in the utilization of resources, which leads to growth. Third, FDI leads to increases in exports as a result of increased capacity and competitiveness in domestic production. Empirical analysis of the positive relationship is often said to depend on another factor, called “absorptive capacity”, which includes the level of human capital development, type of trade regimes and the degree of openness (Borensztein et al., 1995, 1998).
One of the most salient features of today’s globalization drive is conscious encouragement of cross-border investments, especially by trans-national corporations and firms (TNCs). Many countries and continents (especially developing) now see attracting FDI as an important element in their strategy for economic development. This is most probably because FDI is seen as an amalgamation of capital, technology, marketing and management. Sub-Saharan Africa as a region now has to depend very much on FDI for so many reasons, some of which are amplified by (Asiedu, 2001). The preference for FDI stems from its acknowledged advantages (Sjoholm, 1999 and Obwona, 2001, 2004). The effort by several African countries to improve their business climate stems from the desire to attract FDI. In fact, one of the pillars on which the New Partnership for Africa’s Development (NEPAD) was launched was to increase available capital to US$64 billion through a combination of reforms, resource mobilization and a conducive environment for FDI (Funke and Nsouli, 2003). Unfortunately, the efforts of most countries in Africa to attract FDI have been futile. This is in spite of the perceived and obvious need for FDI in the continent. The development is disturbing, sending very little hope of economic development and growth for these countries. Further, the pattern of the FDI that does exist is often skewed towards extractive industries, meaning that the differential rate of FDI inflow into sub-Saharan African countries has been adduced to be due to natural resources, although the size of the local market may also be a consideration (Morriset, 2000 and Asiedu, 2001).
Include Source Nigeria is turning out to be one of the most attractive countries in terms of foreign investment inflows. Foreign Direct Investment increased from less than US$ 1billion in 1990 to US$ 1.2billion in 2000, US$1.9 billion in 2004, US$ 2.3billion in 2005 and US$ 4.5 billion in 2006. As percentage of GDP, Foreign Direct Investment has increased substantially in recent years. The same pattern is witnessed in portfolio investment, which grew from US$0.2 billion in 2003 to US$
2.9 billion in 2005 and US$ 0.92 billion in 2006. This is attributable to the economic reforms and the resulting of macroeconomic stability, which have instilled great credibility in the Nigerian economy. Home remittances are also becoming an increasingly important catalyst to growth in Nigeria. In 2004, Nigeria received an estimated US$ 2.26 billion in home remittances; this has continued to increase remarkably with a recorded figure of over US$7 billion in 2006 (Bello,
2006). Nigeria’s economy has experienced strong growth in recent years. Real GDP growth averaged 7.8 percent from 2004 to 2007, and growth of 6.4 percent in 2007 exceeded the low-income sub-Saharan (LI-SSA) median (4.0 percent), the LI median (6.0 percent), and the rate in Indonesia (6.3 percent), although it was lower than the rate in Kenya (7.0 percent) (see Figure 1.1). Oil accounts for nearly 40 percent of GDP, but from 2001 to 2006—except in 2003—real growth in other sectors outpaced growth in the oil sector (IMF, 2008) Sectors that have experienced particularly strong growth include telecommunications, which has been liberalized and privatized over the past decade, and wholesale and retail trade. Agriculture has also shown some growth, although it remains far from fulfilling its potential (Economist Intelligent Unit, 2008).
Nigeria’s per capita GDP is high relative to GDP in other LI-SSA countries. In purchasing power parity dollars, GDP per capita grew from $1,597.90 in 2003 to
$2,034.60 in 2007—an average annual growth rate of 5.6 percent. It is now far higher than the LI-SSA’s median per capita GDP ($1,018.00) and Kenya’s ($1,359.00) but still much lower than Indonesia’s ($3,234.00). In 2007 Nigeria had an estimated gross domestic product (GDP) of US$166.8 billion according to the official exchange rate and US$292.7 billion according to Purchasing Power Parity (PPP). GDP rose by 6.4 percent in real terms over the previous year. GDP per capita was about US$1,200 using the official exchange rate and US$2,000 using the PPP method. About 60 percent of the population lives on less than US$1 per day. In 2007 the GDP was composed of the following sectors: agriculture, 17.6 percent; industry, 53.1 percent; and services, 29.3 percent. In 2006 Nigeria received a net inflow of US$5.4 billion of Foreign Direct Investment (FDI), much of which came from the United States. FDI constituted 74.8 percent of gross fixed capital formation, reflecting low levels of domestic investment. Most FDI is directed toward the energy sector. Between 2008 and 2020, Nigeria hopes to attract US$600 billion of FDI to finance its Vision 2020 policy to transform the country’s economy into one of the world’s 20 largest, see figure 1.1 below (Library of Congress, 2008).
Over the past two decades, many countries around the world have experienced substantial growth in their economies, with even faster growth in international transactions, especially in the form of Foreign Direct Investment (FDI). The share of net FDI in world GDP has grown five-fold through the eighties and the nineties, making the causes and consequences of FDI and economic growth a subject of ever-growing interest. The concept of sustainable economic growth presents an immense challenge for policy makers especially in developing countries. The issues underlying the concept of economic growth have become even more distinct in the prevailing era of globalisation where business processes and decisions have become a “global” trait as opposed to the historical national traits. With globalisation, there has been increased deregulation and liberation of international markets that has led to increased trade and international investment across boundaries of countries.
Up until the late 1980s, most of the developing countries relied on bilateral and multilateral donor assistance (Overseas Development Assistance – ODA) as a source of project development finance. The decade between 1990 and 2000 witnessed a remarkable and consistent decrease in development assistance to developing countries that forced them to search for alternative and sustainable sources of financing. Subsequently, by 1998, Foreign Direct Investment had emerged as the largest source of capital for developing countries rising from US$174 billion in 1992 to US$664 billion in 2001, (Towards Earth Summit, 2002). To date, the growth in Foreign Direct Investment shows that sustainable growth for several developing countries is progressively being influenced by Multinational Enterprises (MNEs) through Foreign Direct Investment flows.
Thus, attracting Foreign Direct Investment has become very crucial for most countries because of its perceived positive impact on economic growth and development. Many countries have undertaken structural and regulatory reforms such as privatisation of state enterprises, liberalisation of their foreign exchange markets and establishment of fiscal incentives like tax holidays in order to attract more Foreign Direct Investments. The quest by developing countries for increased Foreign Direct Investment stems from the assumption that Foreign Direct Investment leads to economic benefits within the host country, which assumptions
are based on economic theory. In addition, there is existing empirical research that has further highlighted the benefits of Foreign Direct Investment. According to World Bank, developing countries should endeavour to attract more Foreign Direct Investment because it encourages production improvements, contributes to the advancement in technology, boosts employment opportunities, bolsters business sector competition and creates exports. In their article on Foreign Direct Investment and Sustainable Growth, (Fortanier and Maher, 2001) indicated that Foreign Direct Investment through multinational enterprises is an influential and effective means to propagate technology from developed to developing countries. Fortanier and Maher further indicate that Foreign Direct Investment is habitually the only source of innovative and new technologies.
Empirical research studies also support the assertion that Foreign Direct Investment positively contributes to the enhancement of the economies of host countries. According to Mansfield and Romeo (1980), the technology that comes with Foreign Direct Investment is newer compared to that sold through licensing. Also Romer(1993) noted that Foreign Direct Investment is beneficial because it narrows the “idea or knowledge gap” between the developed and host countries and provides more growth opportunities. In addition, Foreign Direct Investment inflows bring other tangible and intangible benefits which substantially impact on economic growth and development. For example, Foreign Direct Investment inflows through mergers and acquisitions can bring better managerial and organisational skills. According to Fortanier and Maher (2001), corporate governance is increasingly becoming a critical feature for cross border investment decisions and that good corporate governance enhances the confidence of investors.
Whereas empirical studies show that Foreign Direct Investments lead to economic growth of host countries, there are other studies that have found contradictory results. In some instances, it has been found that it is economic growth or its prospect that leads to an increase in Foreign Direct Investment and not vice versa. According to Gorg and Greenaway (2002), Foreign Direct Investment has negative rather than positive spillovers in transition economies. The absence of positive spillovers is attributed to the size of the economies. In his paper, Joze (2003)
indicates that the assertion that Foreign Direct Investment bolsters business competition in host economies may either be true or false. He indicates that sometimes multinational enterprises “crowd out” or force out domestic firms thus reducing competition.
Most countries strive to attract Foreign Direct Investment (FDI) because of its acknowledged advantages as a tool of economic development. Africa – and Nigeria in particular – joined the rest of the world in seeking FDI as evidenced by the formation of the New Partnership for Africa’s Development (NEPAD), which has the attraction of foreign investment to Africa as a major component. FDI can also be seen as an investment made to acquire a lasting management interest (normally 10% of voting stock) in a business enterprise operating in a country other than that of the investor defined according to residency World Bank (1996). Such investments may take the form of either “greenfield” investment (also called “mortar and brick” investment) or merger and acquisition (M&A), which entails the acquisition of existing interest rather than new investment. In corporate governance, ownership of at least 10% of the ordinary shares or voting stock is the criterion for the existence of a direct investment relationship. Ownership of less than 10% is recorded as portfolio investment. FDI comprises not only merger and acquisition and new investment, but also reinvested earnings and loans and similar capital transfer between parent companies and their affiliates. Countries could be both host to FDI projects in their own country and a participant in investment projects in other countries. A country’s inward FDI position is made up of the hosted FDI projects, while outward FDI comprises those investment projects owned abroad.
The linkage between FDI and economic growth has been the subject of controversy and considerable research for many decades. Interest in the area has been revived in recent years largely due to the globalisation of the world economy and to the recognition that multinational corporations play an increasingly important role in trade, capital accumulation and economic growth in developing countries. Three developments has added an additional twist to the literature on the FDI-led growth study, particularly in the area of empirical studies. First, previous econometrics studies based on the assumption that there is one way-causality from FDI to
economic growth has been noted and criticised in the study of (Kholdy, 1995). In other words, not only FDI can cause economic growth (with either positive or negative effects), but economic growth can also affect the inflow of FDI. Failure to consider either direction of such causality can lead to an inefficient estimation of the impacts of FDI/GDP on GDP/FDI and hence is subject to the problem of simultaneity bias. Second, the so-called ‘new growth theory’, as propounded by Paul Romer has resulted in some reappraisal of the determinants of growth in modelling the role played by FDI in the growth process (Romer,1994). Third, new developments in econometric theory, such as time series concepts of cointegration and causality testing, have further expanded the debated on the FDI-growth relationship.
Foreign Direct Investment (FDI) and economic growth nexus has spurred volumes of empirical studies on both developed and developing countries. This nexus has been studied by explaining the determinants of both growth and FDI, the role of Trans-National Companies (TNCs) in host countries, and the direction of causality between the two variables. Empirical studies on the importance of inward FDI in host countries suggest that the foreign capital inflow augment the supply of funds for investment thus promoting capital formation in the host country. Inward FDI can stimulate local investment by increasing domestic investment through links in the production chain when foreign firms buy locally made inputs or when foreign firms supply source intermediate inputs to local firms. Furthermore, inward FDI can increase the host country’s export capacity causing the developing country to increase its foreign exchange earning. FDI is also associated with new job opportunities and enhancement of technology transfer, and boosts overall economic growth in host countries. A number of firm-level studies, on the other hand, however, do not lend support for the view that FDI necessarily promotes economic growth, and this prompted the researcher to investigate into the subject matter.
Nigeria has the potential to become Sub-Saharan Africa’s largest economy and a major player in the global economy because of its rich human and material resources. With its large reserves of human and natural resources, Nigeria has the potential to build a prosperous economy, reduce poverty significantly, and provide
the health, education, and infrastructure services its population needs. However, this has not been achieved because all major productive sectors have considerably shrunk in size with the over dependence on oil. Nigeria as a country, given her natural resource base and large market size, qualifies to be a major recipient of FDI in Africa and indeed is one of the top three leading African countries that consistently received FDI in the past decade. However, the level of FDI attracted by Nigeria is mediocre (Asiedu, 2003) compared with the resource base and potential need. Further, the empirical linkage between FDI and economic growth in Nigeria is yet unclear, despite numerous studies that have examined the influence of FDI on Nigeria’s economic growth with varying outcomes (Oseghale and Amonkhienan, 1987; Odozi, 1995; Oyinlola, 1995; Adelegan, 2000; Akinlo, 2004). Most of the previous influential studies on FDI and growth in sub-Saharan Africa are multi country studies. However, recent evidence affirms that the relationship between FDI and growth may be country and period specific. Also (Asiedu, 2001) submits that the determinants of FDI in one region may not be the same for other regions. In his study on FDI and economic growth in Nigeria Adeolu (2007), only investigated the empirical relationship between non- extractive FDI and economic growth in Nigeria and examined the determinants of FDI into the Nigerian economy and suggest that the determinants of FDI in Nigeria are market size, infrastructure development and stable macroeconomic policy and that although the overall effect of FDI on economic growth may not be significant, the components of FDI do have a positive impact. In the same vein, the determinants of FDI in countries within a region may be different from one another and from one period to another.
- STATEMENT OF RESEARCH PROBLEM
Despite the plethora of studies on FDI and economic growth in Nigeria, the existing empirical evidence on the causal relationship between Foreign Direct Investment and economic growth and the associated benefits is very inconclusive. In spite of a seemingly positive association between FDI and economic growth, the empirical literature has not reached a consensus on the direction of this impact however suggesting that Foreign Direct Investment can be either beneficial or harmful to economic growth. Moreover, in the framework of the developing countries like ours, little research has yet been done on the topic. The principal
driving force for this work is that for developing economies, and for Nigeria in particular, the issue of economic growth is an important one. These countries have been stimulating growth with the help of various techniques, including policies that would aim at foreign capital and technology transfer. It is thus, of interest to investigate whether the start of growth can be attributed to an increased inflow of FDI into the country over the period under review. It becomes natural therefore to ask: if the growth which has been experienced in the economy for the past years was as a result of the contribution of Foreign Direct Investment or if the country has already attained this growth level before attracting Foreign Direct Investment?
The recent theoretical developments in the area of economic growth suggest that successful developing countries were able to grow in large part due to the “catch up” process in the level of technology Borenzstein et al (1998). One of the major channels of the access to advanced technologies is Foreign Direct Investment. Thus, an investigation of enhanced economic growth through the advanced in technology can be closely associated with modelling the relationship between growth and Foreign Direct Investment. Again, recent theoretical developments allow researchers to model and evaluate not only the short-run, but also the long- run impact of Foreign Direct Investment on growth. A closer examination of these previous studies reveals that conscious effort was not made to take care of the fact that more than 60% of the FDI inflows into Nigeria is made into the extractive (oil) industry.
Hence, these studies actually modelled the influence of natural resources on Nigeria’s economic growth. Most of the other empirical research that has been undertaken in this area has used panel data for a number of countries to establish the causal relationships. The results of studies carried out on the linkage between FDI and economic growth in Nigeria are not unanimous in their submissions. Due to this reason, it therefore becomes difficult to ascertain the direction of FDI and economic growth relationship in Nigeria. There is therefore limited exhaustive country specific research studies to establish the causal relationship and interaction between Foreign Direct Investment and economic growth. Chowdhury and Mavrotas (2005) proposed that individual country studies be carried out to
ascertain this causal relationship. This thus provides a major incentive for this study.
- OBJECTIVES OF THE STUDY
The objectives of this study include:
- To ascertain the extent at which Foreign Direct Investment inflow influences economic growth in
- To establish whether there is any kind of relationship between economic growth and Foreign Direct Investments in
- To find out whether there is a bi-directional relationship between Foreign Direct Investments and economic growth in
- RESEARCH QUESTIONS
- To what extent does the inflow in Foreign Direct Investment influence economic growth?
- Is there a long-run causal relationship between Foreign Direct Investment and economic growth?
- Is there a bi-directional relationship between Foreign Direct Investment and economic growth?
IF YOU CAN'T FIND YOUR TOPIC, CLICK HERE TO HIRE A WRITER»
