Investment 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
Outline of Presentation • Introduction • Patterns and Trends of FDI in Africa • Investment Climate & FDI • Business Environment & Doing Business Africa • Empirical Model, Data, & Results • Conclusions & Policy Recommendations
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
Introduction • Developed countries are the preferred destination of FDI • Over 50 % of world’s shares go to developed countries
Introduction • Distribution of FDI inflows among the developing countries are uneven. • FDI in Africa remains small and lowest
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
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.
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?
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
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.
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
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.
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
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
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
Ease of doing business ranking RegionAve.Ranking OECD 30 East Asia & Pacific 83 Middle East & N Africa 92 Latin America & Caribbean 95 South Asia 118 Sub-Saharan Africa 139 Source: WB 2010
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)
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
Why is it important to do this study? • There is a perception that FDI in Africa is mainly driven by natural resource endowment. • Since natural resource endowment is exogenous variable, resource-poor countries have small chance to attract FDI. • FDIs in extracting industries have limited linkages to other sector of the economy. • Reforms to improve business environment/regulations is a costly exercise and therefore, is it really worth it?
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.
Empirical Model FDI = F (policy variables, economic variables, governance/political variables, others e.g. structural variables)
Data • Two sets of data from World Bank • CPIA = country policy and institutional assessments * Macroeconomic ratings * Transparency ratings * Business ratings
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
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.