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

World’s FDI Inflows, 2009

Introduction Distribution of FDI inflows among the developing countries are uneven. FDI in Africa remains small and lowest

Distribution of FDI, Developing Regions, 1970-2009

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 Region Ave. 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

Regression Results using CPIA Data Dependent variable: FDI Variable Regression 1: Coefficients Regression 2: Coefficients Constant Business Rating Macro Rating Tranparency Rating Oil_production Dummy GDP -463.09 (-9.01) *** 69.43 (6.91) *** 76.81 (6.95) *** 51.73 (2.86) *** 653.21 (13.53) *** .. -46.35 (-1.82) * 11.42 (2.02) ** -14.01 (-3.06) *** 11.76 (0.78) 231.41 (4.08) *** 0.06 (12.67) *** Adj R2 N = 38 countries Total panel = 152 observations 0.14 0.53

Panel data estimation with Ease of doing Business Index Dependent variable: FDI Variable Regression 1: Coefficients Regression 2: Constant Ease of doing business Inflation Population Openness Oil_dummy Transparency ratings 275.02 (1.31) -2.71 (-2.45)** -33.78 (-4.69)*** 31.03 (8.56)*** 1.39 (1.68)* 845.25 (3.87)*** .. -195.16 (-0.49) -4.06 (-2.71)*** -45.61 (-3.78)*** 27.54 (6.36)*** 3.50 (1.94)* 361.06 (1.58)* 207.33 (2.74)*** Adj R2 No of countries Total panel obs. 0.61 35 70 0.75 25 50

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.

Thank you