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FDI in Africa: Why do select countries do better?

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2002
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While the stock of foreign direct investment in Africa increased significantly between 1980 and 2000, from slightly more than $32.7 billion to just under $150 billion, Africa’s share of new global FDI inflows in 2000 was a meager 0.7 percent. In other words, the volume of FDI has increased strongly since the mid-1980s, but Africa has been unable to keep pace with other regions in attracting its share of new direct investment.

Within Africa, FDI is heavily concentrated in a small group of countries, most notably those richly endowed with oil and mineral resources; nearly three-quarters of total direct investment from overseas goes to this group, which includes Angola, Nigeria, and South Africa. To determine why certain African countries are able to attract fairly large amounts of FDI, Basu and Srinivasan eschewed a regionwide study and confined their analysis to selected case studies covering countries (other than South Africa and the major oil exporters) for which reliable information on capital flows and policies is available. In particular, their study focuses on seven countries with reasonable amounts of FDI diversified across various sectors: Botswana, Namibia, Lesotho, Swaziland, Mauritius, Mozambique, and Uganda.

A critical mass of mutually reinforcing measures must be in place before countries can claim a larger share of FDI flows.

What drives investment?

Basu and Srinivasan set up a simple framework for analyzing FDI by categorizing these seven countries into four groups, based on the considerations likely to be most important in driving investment: a country’s natural resources; “specific” locational advantages; policies that actively target inbound foreign investment; and recent economic and structural reforms. While acknowledging that some combination of these four considerations may be at play in any direct investment decision, the authors point to strong evidence that, in most countries, one or a limited subset of these considerations can be identified as predominant.

Natural resources. Botswana and Namibia are among the African countries with abundant natural resources. FDI targeting the oil and minerals sectors of a number of economies—including those of Botswana and Namibia—has been highly profitable, although accompanied by significant risk. But since FDI has been diversified across sectors rather than concentrated solely in natural resources in Botswana and Namibia, the authors observe that sound economic policies within stable, democratic political systems have played a major part in attracting sizable FDI flows. Membership of these countries in the Southern African Customs Union and other regional organizations also seems to have positively influenced FDI inflows, since investors can gain easier access to markets in South Africa and other countries in the subregion.

Locational advantages. Lesotho and Swaziland offered investors specific advantages linked to their proximity to South Africa. By setting up manufacturing subsidiaries in these countries in the late 1980s and early 1990s, investors seeking access to South Africa’s large market were able to circumvent the apartheid era’s economic sanctions against the country. These countries also offered a good base for companies seeking to take advantage of reduced tariff barriers within the southern African region’s Preferential Trade Area and in trade with European Union countries under the Lomé Convention. As with Botswana and Namibia, political stability and sound economic policies increased their attractiveness to foreign investors. Low-cost and productive workforces and, to a smaller extent, generous tax incentives also likely influenced investor decisions.

Tailored policies. Mauritius is a striking example of a country that has tailored policies specifically to attract foreign investment—such as sustained policies of liberalization, economic diversification, and export-oriented development. Because of its small size and lack of natural resources, Mauritius realized early on it would have to put in place policies and measures targeting foreign investors—such as export processing zones and tax incentives—to try to compete with other developing economies that provide an appealing export base. But here, again, the authors find that political stability and sound economic policies have been of overarching importance in attracting investors. Other features of the Mauritian investment environment considered critical in attracting foreign investors are bilingual and low-cost labor as well as good infrastructure.

Economic and structural reforms. Mozambique and Uganda stand out as countries that had earlier been shunned by investors but have recently aroused significant investor interest after they successfully implemented far-reaching and sustained macroeconomic and structural reforms. Both of these resource-rich countries have emerged from periods of political instability, civil strife, and poor economic policies to embrace market-oriented reforms that give increasing priority to creating a flourishing private sector. Foreign investors have responded positively to reforms that have reduced the state’s role in the economy, shifted government spending priorities to improve the quality and availability of physical and human capital, and removed impediments to foreign investment.

Even countries lacking natural resources or locational advantages can draw investors … by following sound economic policies within an open political environment.

What’s the secret?

Above all, the authors find that countries that have successfully attracted large amounts of FDI tend to share certain traits: they promote political and macroeconomic stability on a sustained basis and they put in place essential structural reforms. Strong, pro-democracy political leadership that has embraced policies to overcome social and political strife and a firm commitment to economic reform are key factors linked with sizable FDI inflows.

Prospective investors also tend to favor those countries that pursue sound fiscal and monetary policies, supported by an appropriate exchange rate policy, and promote an operating environment that minimizes obstacles to private sector development. The authors also find that special incentives targeted to foreign investors by themselves do not appear to have significantly helped countries attract well-diversified investment.

What can African countries that have lagged these seven “success stories” do to catch up? The authors conclude that a critical mass of mutually reinforcing measures must be in place before countries can claim a larger share of FDI flows. Eliminating regulatory and other obstacles to private-sector development and implementing supporting structural reforms are essential to attracting these capital flows. In addition, since political stability is a vital determinant of where investors will choose to set up their operations overseas, progress toward conflict resolution is essential. And, as the country case analysis reveals, even countries lacking natural resources or locational advantages can draw investors to their shores by following sound economic policies within an open political environment.

IMF mission outlines Argentine work on comprehensive economic program

On March 15, at the conclusion of an IMF mission’s discussions with the Argentine authorities, Anoop Singh, Director for Special Operations and head of the mission to Argentina, stated that “The mission was encouraged by the government’s determination to implement a comprehensive economic program, in close cooperation with the inter national-financial institutions.

“Such a program aims at stabilizing Argentina’s financial situation and establishing the foundations for resuming growth. The discussions centered on putting fully in place a realistic macroeconomic framework, consistent fiscal and monetary policies, fundamental structural and institutional reforms to restore confidence in the banking system, and steps to establish an orderly and fair business environment.

“On the macroeconomic framework, the program aims at containing inflation and restoring confidence as key conditions for minimizing further output decline and resuming growth. Monetary policy would play a key role through containing pressures on the peso within the framework of a freely floating exchange rate system. The central bank has already initiated auctions of central bank bills and is working with commercial banks to develop savings instruments with positive real rates of interest.

“A primary concern of the mission was to address the issue of fiscal sustainability while protecting the poorest members of society. As a first step, the government intends to secure a significant improvement in the primary balance of the consolidated public sector in 2002, through the combined efforts of the central government and the provinces. Approval of the 2002 budget by Congress, as well as the recent agreement between the government and provincial governors, are important steps in this direction. In the coming weeks, the government will develop the additional measures that will be needed to achieve the objectives in this area, including the finalization of a core social safety net to protect the poor.

“Anticipated structural and institutional reforms include measures to rebuild confidence in the bank and corporate sectors, thereby helping to create the conditions for the dismantling of the freeze on bank deposits. Steps have already been announced to inject public capital into banks and restore their adequate capitalization, and begin liberalizing exchange controls. The government and the central bank are working on additional measures to restore depositor and investor confidence. This includes creating an internationally recognized insolvency regime. The government also intends to move quickly to establish close contacts with its external creditors aimed at normalizing relations and restoring trade finance.”

The mission team will continue its work at IMF headquarters, and staff will remain in close contact with the Argentine authorities as they elaborate the details of their comprehensive strategy.

The full text of IMF News Brief 02/20 is also available on the IMF’s website (www.imf.org).

Copies of the forthcoming Working Paper, Foreign Direct Investment in Africa—Some Case Studies, by Anupam Basu and Krishna Srinivasan, will be available for $10.00 each from IMF Publications Services. See page 87 for ordering information.

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