The Impact of FDI Determinants on FDI inflow to the Central African Republic

The Impact of FDI Determinants on FDI inflow to the Central African Republic: Empirical Analyses

Babette Zoumaraa*, and Presley K. Wesseh, Jr.b

Abstract

With Autoregressive Distributed Lag (ARDL) bound test technique to cointegration and Error Correction Model (ECM), the impact of FDI determinants on FDI to the Central African Republic (CAR) from 1965 to 2010 was empirically examined. Results show that all regressors were of the order of one [I (1)] except inflation rate [I (0)], with stable cointegrating relationship with FDI. Additionally, diagnostic tests proved that the model was correctly specified and reliable; with FDI inflow statistically and positively correlating with market size, inflation and corruption but negatively with openness to trade and political instability. Political instability had strongest negative impact; implying that FDI responds to political instability in CAR more than the rest of the explanatory variables. Therefore, in order to attract the required FDI, the security situation in the country needs to be improved and efforts must be directed towards improving the economic performance of the country by diversifying its economic activities and encouraging private participation. Furthermore, CAR needs to secure its borders by cooperating with its neighbours on possible joint border patrols. For long term policy intervention, good governance and its attendant conditions (rule of law, transparency, accountability, respect for human rights and equal opportunities) and institutions (strong and independent judiciary, opposition, media, electoral commission, security force and public services) must be pursued. Most importantly, higher education must be prioritized and implemented to foster national unity, reduce crime and conflicts, and provide employment, better salaries, and vibrant domestic economic activities to generate revenue for rapid and sustained economic development.

Key words: Cointegration; ARDL Bounds test; FDI determinants; Central African Republic

a * Corresponding author: PhD in Law and Political Science, Graduate from Xiamen University, Fujian Province, China

b China Center for Energy Economic Research, Xiamen University

1. Introduction

1.1. The Central African Republic (CAR)

The Central African Republic (CAR), a landlocked nation has been destabilized and further impoverished since independence (in 1960) as a result of frequent violence (HAC, 2011). It has however, seen relative stability from 2005 (President Bozize assumed power in 2003 and subsequently won presidential elections in 2005 and 2010) until now; nevertheless, unstable socio-economic conditions coupled with degenerating living standards and above all, insecurity has crippled the country (BBC, 2008 a, b). Insecurity hinders the economic development of nations; hence several attempts to promote peace and stability aimed at reducing insecurity in the country have been made in the last decades. Yet, its geographical location (it is surrounded by warring nations-Chad, Sudan and DRC) worsened the condition creating not only explosive situation but a poverty-stricken country with unfavourable climate for attracting foreign investment for developments (Ghura and Mercereau, 2004). Notwithstanding the fact that the CAR is a country with many blessed and untapped natural resources, it is about the poorest in the world (CAR-CEA, 2010). Respective political authorities of CAR have tried saving the economy by enacting decrees, laws and instituting many intervention measures, with little success; even with the backing of the IMF and World Bank. In desperation, successive governments directed efforts on attracting donor support in the form of foreign direct investment (FDI) to augment and accelerate economic growth.

1.2. Foreign Direct Investment (FDI)

FDI may simply be defined as a class of investment where a resident in one economy secures a permanent stake in an enterprise located in another economy (IMF, 1993). Study on the impact of FDI on economic growth has received tremendous attention in the literature (Li, 2010), but with conflated outcomes both for and against its contributions to economic growth (Carkovic and Levine, 2005; Hansen and Rand, 2006). There are basically two types of theological hypotheses on the impact of FDI on an economy: the complementary and the substitution hypotheses (Forgha, 2009); whose central issues are whether FDI increases or decreases trade volume, thereby encouraging or discouraging economic growth (Semyon, 2005). The complementary hypothesis (the vertical FDI theory) which we adopt in this work, suggests that FDI complements domestic savings among other determinants, resulting in economic growth and development (Hajos, 2002). The substitution hypothesis (the horizontal FDI theory) on the other hand argues that FDI discourages and crowds out domestic savings and widens the economic gap between the poor and the rich, thereby discouraging economic growth (Haavelmo, 1963). Consequently, a lot of arguments have been put forward in favour of both hypotheses (Nyong, 2002). Nevertheless, available empirical evidence supports the former (Head and Ries, 2001). For instance, some writers have pointed out and confirmed the substitution hypothesis (Egger and Pfaffermayr, 2005), however, the WTO in its 1996 report on FDI stated categorically and emphatically that ‘there is no serious empirical support for the view that FDI has an important negative effect…’(WTO, 1996). Empirical results are therefore, decisive on the positive contribution of FDI to economic growth (Levine, 2002).

1.3. Determinants of FDI

The role of FDI in facilitating economic development and growth is thus well-known and reported (Li, 2010; Forgha, 2009; Hajos, 2002; Haavelmo, 1963; Alfaro et al., 2006) but the determinants or factors that attract or discourage FDI is varied and country or source dependant (Hermes and Lensink, 2003; Alfaro et al., 2006). For example, advanced technology, capital accumulation and skilled human resource are identified by De Mello as factors enhancing FDI inflow (De-Mello 1997). Barro and Sala-i-Martin cited unproductive public sector, bad governance and corruption as discouraging FDI inflow (Barro and Sala-i-Martin, 1995). A well-developed domestic financial sector is said to be another factor that influences the inflow of FDI (Alfaro et.al, 2006; Choong et.al, 2004, 2005]. For this group, FDI will have positive impact on economic growth only with a well-developed domestic financial sector. Nonetheless, others have shown (empirically) that this sector is not important (Durham, 2004) and does not regulate FDI inflow (Carkovic and Levine, 2005; Li, 2010). Rogoff and others assert that macroeconomic and political imbalances, bag governance, misguided policies, poor growth and infrastructure, hostile environments and uncertainty are the causes of poor FDI inflow to many nations([Rogoff and Reinhart, 2003; Akinlo, 2003; Lemi and Asefa, 2003; Bende-Nabande, 2002; Asiedu, 2002 a). Chenery and Strout argue that skilled labour and high domestic savings attract foreign aid (Chenery and Strout, 1966) more while Kokko and others earmarked advanced technology and good managerial skills as attracting FDI most(Kokko et.al, 1996). Still, high productivity is identified by Markusen and Venables (Markusen and Venables, 1999); endowed natural resource by Helpman and others (Markusen and Venables, 1999) and poor infrastructure is seen by some as the main deterrent of FDI (Lucas, 1990).

1.4. Determinants for CAR

Political instability, bad governance, misguided policies, poor infrastructure, and hostile environments are the main factors seen to be responsible for the poor FDI inflow to typical developing nations like CAR (Akinlo, 2003; Lemi and Asefa, 2003; Bende-Nabande, 2003; Asiedu, 2002); nonetheless, Li Shaomin reported that poor governance and hostile environments do not deter FDI inflow to developing nations, though his study was on China (Li, 2005). Another contention is that exports from those nations are largely undiversified and heavily raw material oriented, making them less competitive in attracting foreign investment (Rotberg, 2008). Instability is possibly the main problem of CAR (BBC, 2008 a, b; Ghura and Mercereau, 2004). Rogoff and Reinhart computed global susceptibility to war and indicated that wars are likely to occur in developing nations (Africa) than in any other part of the world. The susceptibility index for Africa was the highest; about 26.3%. They then showed negative correlation between FDI inflow and conflicts (Rogoff and Reinhart 2003; Collier et al, 2003). Sachs and Sievers echoed this issue arguing that instability (due to high incidence of war, frequent military interventions, religious and ethnic conflicts) is the most important determinant that hinders FDI inflow to developing nations (Sachs and Sievers, 1998). Other reports show that macroeconomic instability (currency crashes, high inflation rate, budget deficits, etc) and poor investment policies (high profit repatriation) are not conducive and limit the ability of developing nations to attract foreign investment (Basu and Srinivasan, 2002). Furthermore, low growth rate per capita output and small domestic markets are identified as the limiting factors (Elbadawi and Mwega, 1997). The absence of good infrastructure (effective telecommunication, transport, power and water supply systems) and skilled labour are also fingered as discouraging foreign investment due to increment in transaction costs and decrease in productivity (Asiedu, 2002 b). Yet, Onyeiwu and Shrestha argues that there is no evidence that good infrastructure has any impact on the FDI inflow to developing nations (Onyeiwu and Shrestha, 2004). Notwithstanding, there are other factors that may account for the low FDI inflow to CAR. One such factors is the over reliance on primary commodities (Timber, Cotton and Diamond). The country rely solely on the export of these commodities for foreign exchange; and due to price fluctuation, it is vulnerable to trade shocks, resulting in high risk which discourages investment (Forgha, 2009; Ghura and Mercereau, 2004). Even though availability of natural resources has long been reported to be positively related to FDI inflow (Basu A and Srinivasan, 2002; Asiedu and Lien, 2011), literature equally show that their abundance, due to economic effects; hinder growth and magnify corruption (Collier and Hoeffler, 2002). Finally, the lack of strong and independent judiciary is a possible deterrent for FDI inflow to the country as foreign investors prefer nations with very good legal and judicial systems to guarantee the security and protection of their property.

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