ABSTRACT
This study aims at establishing the role that inward foreign direct investment (FDI) and institutions played in the industrialisation process of 40 sub-Saharan African countries, over the period of 1996 through 2015. The study used a fixed effect method (FEM) of estimation for the analysis of data which was sourced from the world development indicators (WDI) database of the world bank and the world governance indicators (WGI) database, also of the world bank.
The findings of the study based on the model employed show that inward FDI played a neative role in the industrialisation process of the countries under study. That is to say FDI was detrimental to industrialization. Institutions were however important in the promotion of the manufacturing sector of these countries. Good institutions provide a good business climate that enable the growth of the industrial sector of Sub- Saharan African countries. Other findings from the study showed that Agriculture and Export had a negative relationship with Industrialization, whereas, Imports had a positive relationship with Industrialization.
CHAPTER ONE INTRODUCTION
This chapter gives a general background of the research topic. It further elaborates on the purpose, objective, research questions, significance, scope and limitations of the study. Then, a summary of the remaining chapters of the research work is finally given.
Background of the Study
The African continent has been lagging behind in terms of development, over the past several decades, compared with the rest of the world. Most African countries have failed to diversify their economies, and they usually engage in primary sector activities. These economic activities do not bring the countries much value, as regards the creation of jobs and value added final products (United Nations Economic Commission for Africa, 2013).
Industrialisation is the movement of an economy from a mainly primary sector base to a manufacturing base. Kuznets (1973) also defines it as the structural changes experienced by less developed countries in the transition from an agricultural to an industrial economy, which comes along with societal changes. Industrialisation is widely recognised as a necessity for the development of the African continent. Most developed countries all went through this process in the development of their nations. Some economists have thus hypothesised a theory which states that the industrial sector is the engine of growth in an economy. This is referred to as the “engine of growth argument” (Kaldor, 1967; Cornwall, 1977). Recent empirical studies also confirm
industrialisation as the major driving force of economic development. (Rodrik, 2008; Szirmai and Verpagen, 2011).
Industrialisation however requires high levels of financial investments and technology. Most African countries lack the financial strength and technical resources to industrialise their economies. It is therefore imperative that they attract external sources of financial and technological support, through foreign direct investment (FDI) in their bid to catch up with the industrialised world.
Foreign direct investment (FDI) in Africa has been on the rise for several decades. It rose by as much as 40% between 2014 and 2015. Policy makers and governments have played a major role in this increase in foreign investment inflows. Most countries receiving inward bound FDI provide very generous tax and investment incentives for the investors. Foreign direct investment has now become one of the major sources of finance in developing economies (DenisiaTheories have shown various effects of FDI in a host economy. Dahlman, (2009) and Di Maio, (2009) show that FDI played a pivotal role in the transformation of the economies of some East Asian countries into industrial economies.
The prospective benefits of FDI include increases in employment, export promotion and capital formation. These remain some of the most important reasons for seeking FDI. These allow domestic firms to be more efficient and improve on their performance. FDI inflows is said to have both financial and technological spillovers which propels the host country’s economy in economic growth. Also, Borensztein, Gregorio and Lee (1998) show that host countries could benefit from FDI through forward and backward linkages. When a foreign firm enters into a local economy, it creates a linkage effect. This occurs when multinational firms use local inputs sourced from domestic firms. Hence, more domestic firms will be created to satisfy the needs of
the multinational firms. FDI is preferred to other forms of capital inflows because it tends to be more stable. This reduces the risk associated with sudden fluctuations in flows and leaves the host country less vulnerable.
Vibrant institutions are needed because they create a good economic environment. Institutions may help in reducing the activities that may hinder the normal duties of business. In critiquing the industrialisation policies of most governments, many economists have failed to acknowledge the role institutions tend to play in this process. Many scholars have found that good institutional quality is needed for economic growth and development (Acemoglu, Johnson, Robinson, and Thaichareon, 2003). This simply means that for a country to develop, the government needs to put in the right structures that will enable economic activities to thrive. Research has shown that a good institutional framework always goes hand in hand with economic development (Ranis, 1989). Institutions have the ability to enhance growth or stifle development. Ranis (1989) characterises institutions as having an accommodative ability for economic growth or as being obstructive in the development process through the implementation of bad policies such as sole supplier rights, and domestic market exclusivity, among others. Institutional quality may therefore make or break an economy.
It also has been found that FDI has a greater impact on economic development under certain conditions. Azman-Saini, Baharumshah, and Law (2010) show that under a good institutional environment, FDI has a greater impact on economic growth and development.
Problem Statement
In 2008, the African continent’s exports of natural resources represented 73% of its total exports. When compared to Asia, North America, and Europe which recorded 14%, 20% and 14%
respectively, it is evident that the continents reliance on the primary sector is very high. This kind of trade exposes the continent to exogenous shocks such as sudden price drops. This is alarming and suggests that African countries have put themselves at high risk.
Industrialisation continues to be relevant as an engine of growth in developing countries (Szirmai and Verspagen, 2011). However, African countries still encounter problems in their bid to industrialise. From (Fig 1.1) from 1996 to 2002 it can be seen that there was a slight increase in industrialization of the countries being studied was on the rise. However, after 2003 industrialization has been falling. It is therefore evident that industrial activities in African countries have been on the decline for the period in which the study was conducted even though FDI inflows have seen a number of increases and decreases over the period of study as seen in (Fig 1.2).
A major problem that these countries may face is the mobilization of capital to engage in industrial activities due to the capital-intensive nature of the industry. A good way for the countries to acquire this capital is through Foreign Direct Investment. Economic theory suggest that foreign investment inflows should be growth enhancing. The literature on the effects of FDI on industrialization have been inconclusive. An empirical study found FDI to have a positive and significant influence on industrialization (Rodrıguez-Clare, 1996; Markusen and Venables, 1999). However, Gui-diby and Renard (2015) on the contrary finds no significant relationship between capital inflows and industrialisation in their study which was focused on the African continent. There is a common view that these results may be associated to peculiar characteristics of host economies. This current study would therefore attempt to establish whether FDI would boost the industrialisation process of African countries in the presence of good institutions.
