Table of content

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CHAPTER 1: INTRODUCTION 1

CHAPTER2: LITERATURE REVIEW 8

CHAPTER THREE: THEORETICAL FRAMEWORK AND

RESEARCHMETHODOLOGY 71

CHAPTER FOUR:DATA PRESENTATION &

ANALYSIS OF RESULT 78

CHAPTER FIVE: RECOMMENDATIONS AND

CONCLUSION 86

APPENDIX 91

BIBLIOGRAPHY 97

1

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

A perennial challenge facing all of the world's countries, regardless of their level

of economic development, is achieving financial stability, economic growth, and

higher living standards. There are many different paths that can be taken to

achieve these objectives, and every country's path will be different given the

distinctive nature of national economies and political systems.

Yet, based on experiences throughout the world, several basic principles seem to

underpin greater prosperity. These include investment (particularly foreign direct

investment), the spread of technology, strong institutions, sound macroeconomic

policies, an educated workforce, and the existence of a market economy.

Furthermore, a common denominator which appears to link nearly all high-

growth countries together is their participation in, and integration with, the global

economy

In the wake of the global financial crises, foreign direct investment (FDI) has

been touted as a main supplement of national savings as a means to promoting

economic development. FDI is considered less prone to crisis because direct

investors, typically, have a longer-term perspective when engaging in a host

country. In addition to the risk-sharing properties of FDI, it is widely believed that

FDI provides a stronger stimulus to economic growth in host countries than other

types of capital inflows. The underlying argument is that FDI is more than just

2

capital, as it offers access to internationally available technologies and

management knowhow. (The Economist 2001).

FDI does have some potential negative impacts, the most potent being anti-

competitive and restrictive business practices by foreign affiliates, tax avoidance,

and abusive transfer pricing. Volatile investment flows and related payments may

be deleterious to balance of payments, while some FDI is seen as transferring

polluting activities and technologies, the Niger-Delta region of Nigeria being a

prime example. Moreover, there is often fear that FDI may have excessive

influence on economic affairs, with possible negative effects on industrial

development and national security. The intensity of concerns about these types of

impact is diminishing. FDI being an important aspect of international economic

integration, it is playing a larger role in developing economies. FDI has grown at

rates far greater than those of international trade or output since the late 1980s,

especially among the industrialized countries. Estimates by UNCTAD1 (2002) put

the total stock of FDI capital at 17.5% of global GDP in 2000, more than double

the size in 1990 (8.3%). A direct consequence of the greater presence of foreign-

owned firms is the internationalization of production. Currently, companies that

are under control of foreign investors account for about 11% of global production.

FDI has grown dramatically and is now the largest and most stable source of

private capital for developing countries and economies in transition, accounting

for nearly 50% of all those flows in 2002. The increasing role of FDI in host

countries has been accompanied by a change of attitude, from critical wariness

3

toward multinational corporations to sometimes uncritical enthusiasm about their

role in the development process. The domestic policy framework is crucial in

determining whether the net effects of FDI are positive (UNCTAD, 1999). Thus,

instituting (designing and implementing) a policy mix that maximizes the

potential benefits and minimizes the potential negative effects is very important.

Empirical evidence suggests that some countries have been more successful in

this respect than others (UNCTAD, 1999).

Countries typically act both as host to FDI projects in their own country and as

participants in investment projects in other countries. A country’s inward FDI

position is made up of the hosted FDI projects, while the outward FDI position

consists of the FDI projects owned abroad. Both larger inward and outward FDI

positions may make the domestic economy more sensitive to economic

disturbances abroad in the short run.

1.2 STATEMENT OF THE PROBLEM

Growth in neoclassical theory is brought about by increases in the quantity of

factors of production and in the efficiency of their allocation. In a simple world of

two factors, labour and capital, it is often presumed that low-income countries

have abundant labour but less capital. This situation arises owing to shortage of

domestic savings in these countries, which places constraint on capital formation

and hence growth. Even where domestic inputs in addition to labour, are readily

available and hence no problem of input supply, increased production may be

limited by scarcity of imported inputs (hence the need for capital) upon which

4

production processes in low-income countries are based. Foreign direct

investment readily becomes an important means of helping developing countries

to overcome their capital shortage problem. While FDI inflows have been

increasing in some developing countries, Nigeria has not been successful except

in natural-resource exploitation. Given the importance of FDI to Nigeria as a

strategic source of investment capital, an important question that arises is; how

can Nigeria attract FDI into non-extractive sectors of the economy?

1.3 OBJECTIVES OF THE STUDY

The main purpose of this paper is to provide an assessment of empirical evidence

on the determinants of foreign direct investment in Nigeria. In particular, the

following objectives will be examined:

• To assess the determinants of FDI in Africa, especially Nigeria.

• To evaluate the benefits of FDI on the African economy, especially

Nigeria.

• To recommend suitable policies that will maximize the benefits of FDI in

Nigeria.

1.4 RESEARCH QUESTIONS

The study seeks to provide answers to the following questions:

• What are the determinants of FDI in Nigeria?

• What is the Impact of these determinants on FDI in Nigeria?

• What policies will help enhance the growth of FDI in Nigeria?

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1.5 RESEARCH METHODOLOGY

All data to be analyzed will be gotten from secondary sources. The approach to

be used for this study in answering the research questions and testing the

hypothesis will be descriptive analysis and econometric techniques. Descriptive

Analytical tools such as trend graphs would be used in analyzing the trends of

FDI inflows and econometric techniques would be used in analyzing the factors

that cause FDI to accrue to Nigeria through the Ordinary Least Square (OLS)

regression technique.

1.6 RESEARCH HYPOTHESIS:

In achieving the above stated objective the following hypothesis would be tested:

HYPOTHESIS 1

H1 (0); Market growth does not determine FDI in Nigeria.

H1 (1); Market growth is a significant determinant of FDI in Nigeria.

HYPOTHESIS 2

H2 (0); trade-openness does not determine FDI in Nigeria.

H2 (1); trade-openness is a significant determinant of FDI in Nigeria.

HYPOTHESIS 3

H3 (0): Macroeconomic stability does not determine FDI in Nigeria.

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H3 (1): Macroeconomic stability is a significant determinant of FDI in

Nigeria.

HYPOTHESIS 4

H4 (0): Infrastructure development does not determine FDI in Nigeria.

H4 (1): Infrastructure development is a significant determinant of FDI in

Nigeria.

1.7 MODEL SPECIFICATION

FDI = f (market growth, trade-openness, macroeconomic instability, infra dev)

• Where market growth is proxied by Nominal GDP

• Trade openness is proxied by ratio of imports+exports over GDP

• Macroeconomic Instability is proxied by exchange rates and

• Infrastructure development is proxied by Electricity consumption

Therefore LogFDI = f (LogNGDP, EXR, TOPN, ELCON)

Where:

LogFDI = Natural Log of Foreign Direct Investment, the dependent variable,

LogNGDP = Natural Log of Nominal GDP

EXR= Exchange rate

TOPN= trade openness

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ELCON = Electricity Consumption.

In equation form:

LnFDIit = β

0 + β

1 LnNGDP

it + β

2 TOPN

it + β

3EXR

it +β

4ELCON

it + ε

it

1.8 SIGNIFICANCE OF THE STUDY

FDI has been touted as a cure-all for ailing developing economies. Its impact

analysts say, will reverse the trend of poverty, unemployment and under-

development that is pervasive and persistent in developing economies like

Nigeria’s, but not without potential risks. The recent past global financial

crises highlighted the dangers of increasing interdependence of global

economies; therefore this study is important for research purposes for three

reasons: Understanding the peculiarities of the

Nigerian economy as it concerns Foreign Direct Investment, Creating an

enabling environment which maximises its benefits and help determine

primary areas of focus in order to efficiently allocate scarce resource.

8

LITERATURE REVIEW 2.1 INTRODUCTION

Foreign Direct Investment has long been a subject of interest. This interest has

been renewed in recent years due to strong expansion of world FDI flows

recorded since the 1980’s, an expansion that has made FDI even more important

than trade as a vehicle for international economic integration. Given this fact, it

should come as no surprise that a large number of theoretical explanations as to

the very existence of have been advanced over the years, with many studies

focusing on the investigation of the determinants of such investment. However,

despite the abundance of research, there is at present no universally accepted

model of FDI, as there is still some confusion over what are the key factors

capable of explaining a country’s propensity to attract investment by

Multinational Corporations (MNCs). These unresolved issues are of special

importance to developing countries that now more than ever seek to attract FDI to

fuel economic growth.

Foreign direct investment combines aspects of both international trade in goods

and international financial flows, but is a phenomenon much more complex than

either of these. An essential concept that helps to understand the topic of

discussion is globalization, which is best comprehended in economic and

financial terms. Globalisation may be defined as the broadening and deepening

linkages of national economies into a worldwide market for goods, services and

capital. Perhaps the most prominent face of globalization is the rapid integration

of production and financial markets over the last decade; that is, trade and

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investment as the core driving forces behind globalization. Foreign direct

investment (FDI) has been one of the core features of globalization and the world

economy over the past two decades. More firms in more industries from more

countries are expanding abroad through direct investment than ever before, and

virtually all economies now compete to attract multinational corporations

(MNCs). The past two decades have witnessed an unparalleled opening and

modernization of economies in all regions, encompassing deregulation, removal

of monopolies and privatization and private participation in the provision of

infrastructure, and the reduction and simplification of tariffs. An integral part of

this process has been the liberalization of foreign investment regimes. Indeed, the

wish to attract FDI has been one of the driving forces behind the whole reform

process. Although the pace and scale of reform have varied depending on the

particular circumstances in each country, the direction of change has not. For

developing economies like Nigeria’s FDI is sought as a principal means of capital

augmentation especially since remittances and other development assistance have

declined drastically since the recent global financial crises. FDI can play a key

role in improving the capacity of the host country to respond to the opportunities

offered by global economic integration, a goal increasingly recognized as one of

the key aims of any development strategy.

2.1.2 FDI (DEFINITION)

FDI is an investment made abroad either by establishing a new production facility

or by acquiring a minimum share of an already existing company (Bannock et al,

1998; Ethie, 1995; Lawler and Seddighi, 2001). Unlike foreign bank lending

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(FBL) and foreign portfolio investment (FPI), FDI is characterized by “the

existence of a long-term relationship between the direct investor and the

enterprise and a significant degree of influence by the direct investor on the

management of the enterprise” (IMF, 1993). A direct investor may be an

individual, a firm, a multinational company (MNC), a financial institution, or a

government. FDI is the essence of MNCs–they are so called because part of their

production is made abroad. Furthermore, MNCs are the major source of FDI –

they generate about ninety-five percent of world FDI flows. When the setting-up

of a new site abroad is financed out of capital raised in the direct investor’s

country, FDI is referred to as greenfield investment (Lawler and Seddighi,

2001). The use of the term greenfield FDI has been extended to cover any

investment made abroad by establishing new productive assets. It does not matter

whether there has been a transfer of capital from the investor’s country (home or

source country) to the host country. Another type of FDI is cross-border or

international merger and acquisitions (M&A). A cross-border M&A is the

transfer of the ownership of a local productive activity and assets from a domestic

to a foreign entity (United Nations, 1998). In the short-term, a country may

benefit more from a greenfield FDI than from a M&A FDI. One of the reasons is

that green- field FDI impacts directly, immediately and positively on employment

and capital stock. The installation of a new industry in a foreign country adds to

this latter existing capital stock and entails jobs creation. These short-run effects

may not be evident so far as M&A FDIs are concerned. The immediate effects on

factors of production are not the only criteria taken into consideration in

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contrasting the benefits and costs from greenfield and M&A FDI, from a recipient

country point of view. Profits not repatriated by direct investors but kept in a host

country to finance future ventures constitute a type of FDI called reinvested

earnings (Kenwood and Lougheed,1999). It often happens that a foreign affiliate

of a MNC undertakes direct investment abroad. Such a FDI is called indirect FDI

because it represents “an indirect flow of FDI from the parent firm’s home

country (and a direct flow of FDI from the country in which the affiliate is

located)” (United Nations, 1998). Non-success in the activities of a foreign

affiliate, unfavorable changes in the recipient country’s FDI policy, strategic

reasons, and other factors lead MNCs to divestment –withdrawal of an affiliate

from a foreign country.

2.1.3 COMPILATION OF FDI FLOWS

The available statistics on flows of FDI between a country and the rest of the

world are classified into two main categories: FDI inflows (or FDI inward flows)

and FDI outflows (or FDI outward flows). A country’s gross FDI inflows at the

end of a given period are the total amount of direct investments this latter has

received from nonresident investors during this period of time (Investments made

in a host country by an affiliate out of funds borrowed locally are not recorded in

the FDI statistics). On the other hand, a country’s gross FDI outflows are the

value of all greenfield and M&A FDIs made abroad by its residents during a

given period of time. As one can see, aggregate FDI flows are based on the

concept of residence and not on the one of nationality. A direct investment made

in Lagos, Nigeria by a Nigerian resident in the U.K. for the last three years is

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regarded as FDI outflow from the U.K. to Nigeria even though the investor is a

Nigerian. An FDI by a South-African firm through its affiliate in Ghana, (indirect

FDI) is not considered as an FDI outflow from South-Africa to Nigeria, but as

from Ghana to Nigeria. According to the IMF (1993) guidelines, an investment

abroad should be recorded by the home country as an outward flow of FDI and by

the recipient country as an inward flow of FDI provided the foreign investor owns

at least 10 percent of the ordinary shares or voting power of the direct investment

enterprise. Divestments by foreign investors from a country are deducted from

this host country’s gross FDI inflows and from the foreign investors’ countries’

gross FDI outflows. Net FDI inflows (in home country) are therefore equal to

gross FDI outflows (in foreign country) minus divestments by foreign Investors

(in home country), and net FDI outflows (in home country) equal gross FDI

outflows (in home country) minus divestments from abroad. The value of all the

productive assets held by the non-residents of a country make up what is called

FDI inward stock. FDI outward stock is the net value of all the productive assets

held abroad by the residents of a country. In practice, the compilation of FDI data

is not as simple as presented herein. Governments especially in less developed

countries (LDCs) face difficulties in collecting FDI data because they do not have

“adequate statistics gathering machinery” (South Centre, 1997). Furthermore,

some countries have accounting conventions different from the IMF (1993)

guidelines. These facts explain the discrepancies between world FDI inflows and

world FDI outflows which normally should be equal. Countries’ balances of

payments contain statistics on FDI flows.

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2.1.4 CLASSIFICATION OF CAPITAL FLOWS

In order to augment and shore-up capital, several options exist to a wanting

economy. Capital flows can be divided between public and private flows. Public

flows consist of official development assistance and aid. Official development

assistance and net official aid record the actual international transfer by the donor

of financial resources or of goods or services valued at the cost to the donor, less

any repayments of loan principal during the same period. Public flows are derived

from two principal sources

• bilateral sources e.g. (developed countries and OPEC) and,

• multilateral sources e.g. (such as the World Bank and its two affiliates: the

international development Association (IDA), and the International

Finance Corporation (IFC), on concessional and non-concessional terms

Private capital flows (also known jointly as foreign private investment) consist of

private debt and non-debt flows. Private debt flows include commercial bank

lending, bonds, and other private credits; non-debt private flows are foreign direct

investment and portfolio equity investment.

Private capital flows can be divided into three broad categories:

• Foreign direct investment,

• Foreign portfolio investment, (bonds and equity), and

• Bank and trade related lending.

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2.2 EMPIRICAL LITERATURE

There does not yet appear to be consensus on all the important determinants of

FDI in the empirical literature. In part, this is because there are different types of

FDI, which are affected by different factors. The empirical work on FDI

determinants generally comes in two forms: investor surveys and econometric or

in-depth case studies. Regarding the determinants of FDIs, it must be stated that

there are substantial differences between the flows that only involve developing

countries, whether between home and host countries, and those in which the host

countries are developing countries. According to Dunning (2002), in the former

case strategic asset-seeking investments take place, in which FDI is used in

mergers and acquisitions, seeking horizontal efficiency. In the second case,

investments are characterized by the search for markets, and resources, thus being

of vertical efficiency.

We review two large investor surveys first. The first is a recent survey of CEOs,

CFOs, and other top corporate executives of the Global 1000 companies by A.T.

Kearney, a global management consulting firm. The survey cites large market

size, political and macroeconomic stability, GDP growth, regulatory environment,

and the ability to repatriate profits as the five most important factors affecting FDI

(Development Business, 1999).

In 1994, the World Bank conducted a survey of 173 Japanese manufacturing

investors on their likelihood of investing in an East Asian country over the

coming three years, on a scale of 1 to 7, with 7 being very likely (Kawaguchi,

1994). Against this subjective probability, the participants were also asked to rank

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various characteristics of the countries, on a numerical scale of 1 to 10, with 10

being very favorable. Using pooled regressions, the Bank found that the most

important determinants were the size of the market; the cost of labor; and FDI

policies. On the last, the investors viewed restrictions on repatriation of earnings,

local content and local ownership requirements as serious disincentives to FDI.

Surveys of investors have indicated that political and macroeconomic stability is

one of the key concerns of potential foreign investors. However, empirical results

are somewhat mixed. Wheeler and Mody (1992) find that political risk and

administrative efficiency are insignificant in determining the production location

decisions of U.S. firms. On the other hand, Root and Ahmed (1979), looking at

aggregate investment flows into developing economies in the late 1960s, and

Schneider and Frey (1985), using a similar sample for a slightly later time period,

find that political instability significantly affects FDI inflows.

Nunnenkamp and Spatz (2002), studying a sample of 28 developing countries

during the 1987-2000 period, find significant Spearman correlations between FDI

flows and per capita GNP, risk factors, years of schooling, foreign trade

restrictions, complementary production factors, administrative bottlenecks and

cost factors. Population, GNP growth, firm entry restrictions, post-entry

restrictions, and technology regulation all proved to be non-significant. However,

when regressions were performed separately for the non-traditional factors, in

which traditional factors were controls (population and per capita GNP), only

16

factor costs produced significant results and, even so, only for the 1997-2000

period.

Garibaldi and others (2001), based on a dynamic panel of 26 transition economies

between 1990 and 1999, analysed a large set of variables that were divided into

macroeconomic factors, structural reforms, institutional and legal frameworks,

initial conditions, and risk analyses. The results indicated that macroeconomic

variables, such as market size, fiscal deficit, inflation and exchange regime, risk

analysis, economic reforms, trade openness, availability of natural resources,

barriers to investment and bureaucracy all had the expected signs and were

significant.

Mottaleb (2007) on a study on developing countries employed OLS estimation

technique and the results showed that countries with large market, large market

potentials and relatively higher contribution of industries to GDP are more likely

to contribute to FDI. There was also a positive relation between internet

availability and FDI. While the coefficient of telephone mainline users, time

required to enforce a contract, time required to start a business, corruption

perception index and merchandise trade were not significant.

In recent years, a flurry of studies has emerged, seeking explanations for why sub-

Saharan Africa has been relatively unsuccessful in attracting FDI (Bhattacharaya

et al., 1996; Collier Asiedu, 2002, 2004). In spite of methodological differences,

the broad conclusions are largely the same. The macroeconomic policy

environment is an important determinant of investment; and trade restrictions,

inadequate transport and telecommunications links, low productivity, and

17

corruption make Africa unattractive to potential investors. Asiedu (2002), for

example, used a cross country regression model comprising 71 developing

countries, half of which are in Africa. She found that FDI is uniformly low in

Africa and a country in Africa will receive less FDI by virtue of its geographical

location. She observed that policies that have been successful in other regions

may not be equally successful in Africa. A higher return on investment and better

infrastructure have a positive impact on FDI to non-SSA countries, but have no

significant impact on FDI to SSA. Openness to trade promotes FDI to SSA and

non-SSA countries, but the marginal benefit from increased openness is less for

SSA. In a complementary study, Asiedu (2004) contends that although SSA has

reformed its institutions, improved its infrastructure and liberalized its FDI

regulatory framework, the degree of reform was mediocre compared with the

reform implemented in other developing countries. As a consequence, relative to

other regions, SSA has become less attractive for FDI. Jenkins and Thomas

(2002) also recognize that Africa is significantly different; they ascribe the lower

geographical spread to an African perspective that instability is endemic.

Collier and Patillo (1999) argue that investment is low in Africa because of the

closed trade policy, inadequate transport and telecommunications, low

productivity and corruption. Cantwell (1997) has suggested that most African

countries lack the skill and technological infrastructure to effectively absorb

larger flows of FDI even in the primary sector and Lall (2004) sees the lack of

“technological effort” in Africa as cutting it off from the most dynamic

components of global FDI flows in manufacturing.

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Onyeiwu and Shrestha (2004) argue that despite economic and institutional

reform in Africa during the past decade, the flow of Foreign Direct Investment

(FDI) to the region continues to be disappointing and uneven. In their study they

use the fixed and random effects models to explore whether the stylized

determinants of FDI affect FDI flows to Africa in conventional ways.

Based on a panel dataset for 29 African countries over the period 1975 to 1999,

their paper identifies the following factors as significant for FDI flows to Africa:

economic growth, inflation, openness of the economy, international reserves, and

natural resource availability. Contrary to conventional wisdom, political rights and

infrastructures were found to be unimportant for FDI flows to Africa. The

significance of a variable for FDI flows to Africa was found to be dependent on

whether country- and time-specific effects are fixed or stochastic.

The low level of FDI to Africa is also explained by the reversible nature of

liberalization efforts and the abuse of trade policies for wider economic and

social goals. Others have singled out unfavourable and unstable tax regimes

(Gastanaga et al. 1998), large external debt burdens (Sachs 2004), the slow

pace of public sector reform, particularly privatization (Akingube 2003) and

the inadequacy of intellectual property protection as erecting serious obstacles

to FDI in Africa.

However, Lyakurwa (2003) has stressed macroeconomic policy failures as

deflecting FDI flows from Africa. According to Lyakurwa, irresponsible fiscal

and monetary policies have generated unsustainable budget deficits and

19

inflationary pressures, raising local production costs, generating exchange rate

instability and making the region too risky a location for FDI. In addition,

excessive levels of corruption, regulation and political risk are also believed to

have further raised costs, adding to an unattractive business climate for FDI.

Using least squares technique on annual data for 1962 – 1974 Obadan (1982)

supports the market size hypothesis confirming the role of protectionist

policies (tariff barriers). The study suggests factors such as market size, growth

and tariff policy when dealing with policy issues relating to foreign investment

to the country. In Nigeria, Ekpo (1997) examined the relationship(s) between

FDI and some macroeconomic variables for the period 1970-1994. The

author’s results showed that the political regime, real income per capita, rate of

inflation, world interest rate, credit rating, and debt service explained the

variance of FDI inflows to Nigeria.

Anyanwu’s (1998) study of the economic determinants of FDI in Nigeria also

confirmed the positive role of domestic market size in determining FDI inflow

into the country. This study noted that the abrogation of the indigenization policy

in 1995 significantly encouraged the flow of FDI into the country and that more

effort is required in raising the nation’s economic growth so as to attract more

FDI. Iyoha (2001) examined the effects of macroeconomic instability and

uncertainty, economic size and external debt on foreign private investment

inflows. He shows that market size attracts FDI to Nigeria whereas inflation

20

discourages it. The study confirms that unsuitable macroeconomic policy acts to

discourage foreign investment inflows into the country.

Adaora Nwakwo (2006) at the 6th global conference on business and

economics identifies market-size, macroeconomic stability, political stability

and the availability of natural resources as statistically significant in

encouraging foreign investment in Nigeria while political instability

discourages foreign investment for the period 1965 to 2003.

Dinda (2009) following a symmetric time series approach examined the

determinants of FDI flow to Nigeria. The results showed that natural resource is

an important determinant of FDI inflow in Nigeria. Hence, the bulk of FDI in

Nigeria can be explained by resource-seeking FDI. Also, macroeconomic factors

like inflation rate, foreign exchange rate and government policies like openness

were the crucial determining factors of FDI flows to Nigeria during the period

1970-2006. The study established that as opposed to most studies for other

countries that market size is not a major determining factor in Nigeria.

Abu and Nurudeen (2010), using time series data from 1979 to 2006, concluded

that that the principal determinants of FDI in Nigeria are the market size of the

host country, deregulation, exchange rate depreciation and political instability,

while variables such as trade-openness and inflation and infrastructure where

statistically insignificant in their model.

In conclusion, recent evidence suggests that foreign direct investment tends to go

to countries with good governance, if one holds constant the size of the country,

21

labor cost, tax rate, laws and incentives specifically related to foreign-invested

firms and other factors. Moreover, the quantitative effect of bad governance on

FDI is quite large.

2.3 FDI THEORIES

The recurring question which the theories of FDI seek to answer is simple; why

would a firm choose to service a foreign market through affiliate production,

rather than other options such as exporting or licensing arrangements?

In broad terms, classical theorists advance the claim that FDI and multinational

corporations (MNCs) contribute to the economic development of host countries

through a number of channels. These include the transfer of capital, advanced

technological equipment and skills (Gao 2005; Mody 2004; Asheghian 2004), the

improvement in the balance of payments, the expansion of the tax base and

foreign exchange earnings, the creation of employment, infrastructural

development and the integration of the host economy into international markets

(Li and Liu 2005). These claims about FDI have been amplified by the

phenomenal economic growth of the newly industrialized countries, Hong Kong,

Taiwan, Singapore and South Korea, especially in the 1980s and early 1990s

(Muchlinski 1995; Ulmer 1980) and more recently by China's impressive

economic growth (Cheung and Lin 2004; UCTAD 2003; World Bank 2003).

Although the first theoretical studies of the determinants of FDI go back to Adam

Smith, Stuart Mill and Torrens, one of the first to address the issue was Ohlin

(1933). According to him, foreign direct investment was motivated mainly by the

22

possibility of high profitability in growing markets, along with the possibility of

financing these investments at relatively low rates of interest in the host country.

Other determinants were the necessity to overcome trade barriers and to secure

sources of raw materials. This is also known as the capital market theory. This

idea was prevalent until the 1960s, as FDI was largely assumed to exist as a result

of international differences in rates of return on capital investment, with capital

moving across countries in search of higher rates of return. Although the

hypothesis appeared to be consistent with the pattern of FDI flows recorded in the

1950s (when many US MNCs obtained higher returns from their European

investments), its explanatory power declined a decade later when US investment

in Europe continued to rise in spite of higher rates of return registered for US

domestic investment (Hufbauer, 1975). The implicit assumption of a single rate of

return across industries, and the implication that bilateral FDI flows between two

countries could not occur, also made the hypothesis theoretically unconvincing.

This theory was further extended to the application of Markowitz and

Tobin’s portfolio diversification theory. This approach contends that in making

investment decisions MNCs consider not only the rate of return but also the risk

involved. Since the returns to be earned in different foreign markets are unlikely

to be correlated, the international diversification of a MNCs investment

portfolio would reduce the overall risk of the investor. Empirical studies have

offered only weak support for this hypothesis. This is not surprising when one

considers the failure of the model to explain the observed differences between

industries’ propensities to invest overseas, and to account for the fact that many

23

MNCs’ investment portfolios tend to be clustered in markets with highly

correlated expected returns.

The industrial organization approach (Hymer, 1960) is based on the idea that

due to structural market imperfections, some firms enjoy advantages vis-à-vis

competitors. Firms constantly seek market opportunities and their decision to

invest overseas is explained as a strategy to capitalize on certain capabilities not

shared by their competitors in foreign countries These advantages (including

brand name/proprietary information, patents, superior technology, organizational

know-how and managerial skills) allow such firms to obtain rents in foreign

markets that more than compensate for the inevitable initial disadvantages (for

example, inferior market knowledge) to be experienced when competing with

local firms within the alien environment, since local firms have superior

knowledge about local conditions). Firms, therefore, invest abroad to capitalize on

such advantages. With these advantages, MNCs would prefer to supply the

foreign market by way of direct investments (in developing countries) instead of

through (direct) exports. In an analogous manner, MNCs would not be willing to

license production to local firms if the local firms were uncertain about the value

of the license or if the know-how transfer costs (property rights) were too high.

Hymer also argued that this conduct by firms, which often results in ‘swallowing

up’ competition affects market structure and allows MNCs to exploit monopoly

and oligopoly powers. Kindleberger (1969) slightly modifies Hymer’s analysis.

Instead of MNC behavior determining the market structure, it is the market

24

structure – monopolistic competition - that will determine the conduct of the firm,

by internalizing its production. Kindleberger argues that market imperfections

lead to FDI, specifically through market disequilibrium, government involvement,

and market failure.

Caves (1971), also develops a similar analysis, in which structure dictates

conduct. FDIs will be made basically in sectors that are dominated by oligopolies,

as a natural response to the characteristics of an oligopoly. This is known as the

oligopolistic reaction theory. If there is product differentiation, horizontal

investments may take place, i.e., in the same sector. If there is no product

differentiation, vertical investments will be made, in sectors that are behind in the

productive chain of firms. The offensive and defensive strategies of firms

operating within imperfect markets have also been examined by Knickerbocker

(1973). He concluded that it is the interdependence, rivalry and uncertainty

inherent in the nature of oligopolies that explains the observed clustering of FDI

in such industries. Higher industrial concentration causes increased oligopolistic

reaction in the form of FDI except at very high levels, where equilibrium is

reached to avoid the overcrowding of the host country market. Also along these

lines we have the studies developed by Graham [(1978), (1998) and (2000)].

According to these studies, the emergence of MNCs is a result of oligopolistic

interaction as firms grow, as a risk reduction strategy. In his most recent study,

the author employs game theory in order to develop a simplified two-country,

one-sector model to analyse the entrance of a firm in a foreign country, and to

study the reaction to the entrance of a firm from another country in the local

25

market. The existence of FDI is further related to trade barriers, as a way of

avoiding uncertainties in supplies, or as a way of imposing barriers to new firms

on the external market.

A second line of studies of the determinants of FDI is based on the idea of

transaction cost internalization. Buckley and Casson (1976) and (1981), and

Buckley (1985) were the first to develop this hypothesis, starting with the idea

that the intermediate product markets are imperfect, having higher transaction

costs, when managed by different firms. Firms aspire to develop their own

internal markets whenever transactions can be made at lower cost within the firm.

Thus, internalization involves a form of vertical integration bringing new

operations and activities, formerly carried out by intermediate markets, under the

ownership and governance of the firm. MNCs have proprietary assets with regard

to marketing, designs, patents, trademarks, innovative capacity, etc., whose

transfer may be costly for being intangible assets, or due to a good sense of

opportunity, or even because they are diffuse, and thus difficult to sell or lease.

The internalization theory emphasizes the intermediary product market and the

formation of international production networks. The theory’s main strength may

lie in its capacity to address the dilemma between the licensing of production to a

foreign agent and own production. Therefore, the firm must make two decisions:

location and mode of control. When production and control are located in the

home country, the firm exports; when production and control take place in the

host country, FDI is made. Normally, these decisions concern the several stages

of product internationalization

26

The product cycle hypothesis (Kuznetz, 1953; Posner, 1961; Vernon, 1966)

postulates that an innovation may emerge as a developed country export, extend

its life cycle by being produced in more favorable foreign locations during its

maturing phase and ultimately, once standardized, become a developing country

export (developed country import). According to this model, since innovations are

labor savers, they initially appear in those countries that are more capital

intensive, especially the US. FDI, therefore, occurs when, as the product matures

and competition becomes fierce, the innovator decides to shift production in

developing countries because lower factor costs make this advantageous. At the

same time, production in richer countries is reoriented towards new products that

incorporate innovations in products and processes. This model was partially

responsible for a set of studies that regarded the spreading of multinational

corporations as being sequential, taking place in stages. The firms would initially

supply the export market, then establish trade representatives abroad, and

eventually end up setting up production in target markets by way of subsidiaries.

This model was primarily intended to explain the expansion of US MNCs in

Europe after the Second World War and, at the time of its inception, could

account for the high concentration of innovations in, and technological superiority

of, the USA. Although during the late 1960s and early 1970s a number of

empirical studies provided results consistent with the hypothesis’ insightful

description of the dynamic process of product development, the model is now

regarded by many as largely anachronistic. First, the technological gap between

the USA and other regions of the world (most notably Europe and Japan) has been

27

eroded. Second, the product life extension which characterizes the maturity phase

is difficult to reconcile with MNCs’ tendency to produce the new product where

factor costs are at their lowest from the start, and opt for a simultaneous

introduction phase of the product worldwide.

Work conducted by a group of Scandinavian researchers at Uppsala University,

however, questioned the explanatory power of the product cycle theory by

emphasizing the limited knowledge of the individual investing firm as the most

significant determinant. This model, known as the internationalization theory

elaborated by Johanson and Wiedersheim-Paul (1975) from the University of

Uppsala (Sweden) states that generally a MNC does not commence its activities

by making gigantic FDIs. It first operates in the domestic market and then

gradually expands its activities abroad. Johanson and Wiedersheim-Paul (1975)

identified a four-stage sequence leading to international production. Firms begin

by serving the domestic market, and then foreign markets are penetrated through

exports. After some time, sales outlets are established abroad until; finally,

foreign production facilities are set up. In contrast to the international trade and

FDI theories, outlined above, internationalization theories endeavor to explain

how and why the firm engages in overseas activities and, in particular, how the

dynamic nature of such behavior can be conceptualized. This research was based

on the experience of Swedish firms.

Dunning reviewed and assessed the main theories advanced to explain the reasons

behind FDI. This model known as Dunning’s eclectic theory attempts to

synthesize all prior theories into a cogent whole. Dunning develops an approach

28

that must be understood, in his view, as a paradigm known as OLI (Ownership,

Location, Internalization). This paradigm may be schematically presented as

follows:

Foreign firms hold advantages over domestic firms in a given sector as a result of

privileged ownership of certain tangible or intangible assets that are only

available to firms, also known as knowledge capital (1). This ownership

advantage may be a product (brand) or process differentiation ability, a monopoly

power, reputation, a better resource capacity or usage, a trademark protected by a

patent, or an exclusive, favored access to product markets Given (1), The second

condition requires that the firm prefer internalizing its ownership advantages

rather than externalizing them. This means that the firm possessing ownership

advantages must deem producing abroad more profitable than selling or leasing

its activities to foreign firms. A firm might prefer internalizing its ownership

advantages in order to protect the quality of its products, to control supplies and

conditions of sales of inputs, to control market outlets(I)(2). This capital can

easily be reproduced in different countries without losing its value, and can easily

be transferred within the firm with low transaction costs. Given (1) and (2), the

foreign firm will decide to produce in the host country if there are sufficient

locational advantages (L) to justify production in that country, and not is any

other such as producing close to final consumers, obtaining cheap inputs, higher

labor productivity, avoiding trade barriers, etc. The extent to which a country‘s

firms possess ownership advantages and internalization incentives, and the

locational attraction of its endowments compared to those of other countries

29

explain its propensity to engage in foreign production. In conclusion, The eclectic,

or OLI paradigm, suggests that the greater the O and I advantages possessed by

firms and the more the L advantages of creating, acquiring (or augmenting) and

exploiting these advantages from a location outside its home country, the more

FDI will be undertaken. Where firms possess substantial O and I advantages but

the L advantages favor the home country, then domestic investment will be

preferred to FDI and foreign markets will be supplies by exports.

The last FDI theory that this paper will review is that by Kojima. According to

Kojima’s theory, there are two types of FDI, macroeconomic and microeconomic.

Macroeconomic FDI responds to change in comparative advantage, whilst

microeconomic FDI does not (Kojima 1982; Kojima and Ozawa 1984).

Macroeconomic FDI according to this theory is that which is undertaken by small

firms in order to facilitate the transfer of production from high wage countries to

low-wage ones. Microeconomic FDI on the other hand is that carried out by large

firms aimed at exploiting oligopolistic advantages in factors as well as product

markets (Gary 1982). Kojima’s theory has been criticized as being grossly

inaccurate and theoretically misleading because his theory rejects the basic

microeconomic determinants of FDI (Arndt 1974). Arndt argues that firms, large

or small, undertake FDI to overcome competition either in their home country or

in a foreign one – an issue synonymous with both macroeconomic and

microeconomic FDI. Other criticisms of Kojima’s theory posit that the

microeconomic determinants of FDI are not an alternative to a macroeconomic

30

theory of FDI. Hence to argue that microeconomic theory fails to explain

macroeconomic phenomena is invalid (Lee 1984).

Other FDI theories worthy of mention include: the Japanese FDI theories, the

diversification theory (Agmond and Lessard), the Appropriability theory (Magee),

e.t.c.

2.3.1 FDI CLASSIFICATION

The literature on FDI identifies at the least four different motives for firms to

invest across

national borders (UNCTAD, 1998). These are:

Market-seeking investment seeks access to new markets that are attractive because

of their size, growth or a combination of both. Market-seeking FDI in services

and other parts of manufacturing can benefit host countries’ consumers by

introducing new products and services, by modernizing local production and

marketing and by increasing the level of competition in the host economies.

However, fiercer competition may also lead to the crowding out of local

competitors, especially if foreign affiliates command superior market power.

Moreover, in the long run, the host countries’ balance of payments is likely to

deteriorate through the repatriation of funds since market-seeking FDI often does

not generate export revenues, especially if the protection of local markets

discriminates against exports. Hence, the growth impact of this type of FDI

should be weaker than the growth impact of efficiency-seeking FDI.

Efficiency-seeking investments aim at taking advantage of cost-efficient

production conditions at a certain location. Important factors that are taken into

31

consideration are the cost and productivity levels of the local workforce, the cost

and quality of infrastructure services (transport, telecommunications), and the

administrative costs of doing business. This motive is predominant in sectors

where products are produced mainly for regional and global markets and

competition is mostly based on price (such as in textiles and garments, electronic

or electrical equipment, etc.) and not on quality differentiation. By contrast,

efficiency-seeking FDI in some parts of manufacturing draws on the relative

factor endowment and the local assets of host economies (UNCTAD, 1998). This

type of FDI is more likely to bring in technology and knowhow that is compatible

to the host countries’ level of development, and to enable local suppliers and

competitors to benefit from spillovers through adaptation and imitation.

Additionally, the world market orientation of efficiency-seeking FDI should

generate foreign-exchange earnings for host economies. As a result, one would

expect a relatively strong

growth impact of FDI in industries that attract efficiency-seeking FDI.

Natural-resource seeking investment seeks to exploit endowments of natural

resources. Naturally, the production and extraction of the resource is bound to the

precise location, but given that most resources can be found in a relatively large

number of locations, companies usually choose locations on the basis of

differences in production costs. These factors are closely linked to the different

motives for FDI in developing economies. For instance, resource-seeking

32

FDI in the primary sector tends to involve a large up-front transfer of capital,

technology and know-how, and to generate high foreign exchange earnings. On

the other hand, resource seeking

FDI is often concentrated in enclaves dominated by foreign affiliates with few

linkages to the local product and labour markets. Furthermore, its macroeconomic

benefits can easily be embezzled or squandered by corrupt local elites. Rather

than enhancing economic growth, resource-seeking FDI in the primary sector

might lead the country into some kind of “Dutch

Disease”.

Strategic-asset seeking investment is oriented towards man-made assets, as

embodied in a highly-qualified and specialized workforce, brand names and

images, shares in particular markets, etc. Increasingly, such FDI takes the form of

cross-border mergers and acquisitions, whereby a foreign firm takes over the

entire or part of a domestic company that is in possession of such assets. In

reality, these motives are seldom isolated from one another. In most cases, FDI is

motivated by a combination of two or more of these factors as shown in table 2.1.

33

Table 2.1

Strategic objective

Economic Determinants

Political Determinants

Other Determinants

Market-seeking FDI

Nominal GDP GDP per capita GDP growth rate Previous FDI Real wage Production costs Transport costs Infrastructure tariffs And other Import restrictions

Ownership policies Price controls Convertibility of foreign exchange Performance requirements Market access constraints Sector-specific control

geographical location cultural differences different languages population local content requirements country specific customer preferences

Efficiency-seeking FDI

inflation exchange rate real wage savings rate domestic investments production costs infrastructure transportation costs previous FDI

market access constraints ownership constraints tax and subsidies price controls performance requirements FDI incentives trade agreements requirements of environmental protection

geographical location availability of suitable workforce existence of suppliers

Natural-resource seeking FDI

price of raw materials infrastructure transportation costs domestic investments

FDI incentives FDI restrictions sector-specific controls

existence and quality of raw materials

existence and

protection of intellectual property

existence of

34

strategic-assets seeking FDI

quality of infrastructure intensity of R&D activities

FDI incentives or restrictions in host country resources risk level, innovation

patents, trademarks, etc.

2.4 FDI IN AFRICA

Regional Trends

FDI inflows into Africa rose to $88 billion in 2008 (World Investment Report

2009) another record level, despite the global financial and economic crisis. This

increased the FDI stock in the region to $511 billion. Cross-border M&As, the

value of which more than doubled in 2008, contributed to a large part of the

increased inflows, in spite of global liquidity constraints. The booming global

commodities market the previous year was a major factor in attracting FDI to the

region. The main FDI recipients included many natural-resource producers that

have been attracting large shares of the region’s inflows in the past few years, but

also some additional commodity-rich countries. In 2008, FDI inflows increased in

all sub-regions of Africa, except North Africa. While Southern Africa attracted

almost one third of the inflows, West African countries recorded the largest

percentage increase (63%). Developed countries were the leading sources of FDI

in Africa, although their share in the region’s FDI stock has fallen over time. A

number of African countries adopted policy measures to make the business

environment in the region more conducive to FDI, although the region’s overall

investment climate still offers a mixed picture. For example, some African

35

governments established free economic zones and new investment codes to attract

FDI, and privatized utilities. However, some countries also adopted less

favourable regulations, such as tax increases.

In the early 1970s, Africa absorbed more FDI per unit of GDP than Asia, and not

much less than Latin America, but by the 1980s this had changed dramatically

(UNCTAD, 1995). The volume of FDI that flows to Africa is not only very low

(as a share of total global FDI flows or even as a share of FDI flows to developing

countries), but also the share is on a steady downward trend for three decades.

Africa accounts for just 2 to 3 per cent of global flows, down from a peak of 6 per

cent in the mid-1970s, and less than 9 per cent of developing-country flows

compared to an earlier peak of 28 per cent in 1976 (UNCTAD 2005). In 2006,

FDI inflow to Africa rose by 20% to $36 billion, twice their 2004 level. Following

substantial increases in commodity prices, many MNCs, particularly those from

developed countries already operating in the region, significantly expanded their

activities in oil, gas and mining industries (UNCTAD 2007).

The 24 countries in Africa classified by the World Bank as oil- and mineral-

dependent have on average accounted for close to three-quarters of annual FDI

flows over the past two decades. FDI in Africa has tended to concentrate in a few

countries. In recent years, just three countries (South Africa, Angola, and Nigeria)

accounted for 55 per cent of the total. The top fifth (10 out of 48 countries)

account for 80 per cent, and the bottom half account for less than 5 per cent. This

trend has held for at least the last three decades, with the top 10 countries

accounting for more than 75 per cent of the continent’s total FDI inflows. In Sub

36

Saharan Africa, the preferred FDI destinations were: Angola, Equatorial Guinea,

Nigeria and South Africa. FDI figures for the respective countries are shown in

table 2.2

Important Note

UNCTAD’s Inward FDI Potential Index assesses each country’s

attractiveness for FDI inflows based on eight variables. The eight variables are:

GDP per capita, real GDP growth for the past ten years, exports as a percentage of

GDP, number of telephone lines per 1000 inhabitants, commercial energy use per

capita, R&D expenditures as a percentage of gross national income, students in

tertiary education as a percentage of total population, and political risk. The

mathematical formula is:

Score = Vi - Vmin

Vmax - Vmin

Where; Vi = the value of a variable for country i, Vmin = the lowest value of a

variable among the countries, Vmax = the highest value of a variable among the

countries

37

table 2.2 source oecd database, organization for economic cooperation and development.)

FDI FDI INFLOWS FDI OUTFLOWS FDI

INFLOWS/GFCF*(

%)

YEAR 2006 2007 2008 2006 2007 2008 200

6

200

7

200

8

INWARD

FDI

POTENTI

AL INDEX

(2006)

ANGOL

A

9063.

7

9795.

8

15547

.7

194.2 911.9 2569.

6

161.

3

156.

4

176.

4

76.0

E/GUIN

EA

1655.

8

1726.

5

1289.

6

51.4 4O.

4

20.5

NIGERIA 13956

.5

12453

.7

20278

.5

227.6 468.0 298.6 116.

1

81.1 103.

1

88.0

S/AFRIC

A

-527.1 5687.

2

9009.

2

6067.

2

2962.

1

-

3533.

3

-1.1 9.5 14.0 74.0

FDI 2006-2008 for four select African countries. (All values are in ($)million USD)

*GFCF: Gross Fixed capital Formation.

38

2.4.1 FDI THEORIES IN AFRICA.

Historical Background.

The 1950s, 1960s and 1970s represented a period of uncertainty for foreign

investors in Africa. Many of their assets or investments were either expropriated

or nationalized by host states. MNCs were viewed as inimical to the economic

development of the developing countries. Based on this assertion, MNCs were

either discriminated against or their role in the host economy severely restricted or

limited (Seid 2002). This also provided a justification for the expropriation of

foreign companies or assets. Many MNCs were stripped of their assets by many

developing countries particularly during the early days of their independence

symbolized a rejection by these countries of being externally dependent upon

"foreigners" (Kennnedy 1992). As Kobrin (1984) observes:

The end of the colonial era and the rise of Third World assertiveness and independence during the late 1960s and early 1970s influenced the preference for expropriation as opposed to regulatory control of behavior ... There was a tendency on the part of many countries to use foreign investment as a symbol of Western industrialization and Western colonialism; expropriation represented a rejection of the general context as well as of the specific enterprise.

However, the hostility directed at MNCs in the 1950s and 1970s has largely

waned. Rather than strangle the development of FDI on the basis that it is a source

of foreign domination and control, many countries have now come to recognize

that positive economic gains can be achieved from the presence of FDI (Kobrin

39

2005). This change in attitude can be attributed to, the slowdown of growth in the

world economy in the mid-1970s, change in political leadership and the scarcity

of financial capital in the wake of the debt crisis of the early 1980s (UNCTAD

1999). Since the 1990s, following the disappearance of commercial bank lending

for most countries, FDI has become the largest single source of finance for

developing countries (Aitken and Harrison 1999). Just about every government is

involved in trying to attract more FDI by promulgating laws and regulations that

are investor friendly. Despite, for instance, the likelihood of harmful tax

competition resulting from tax concessions given to MNCs, the 1991 UNCTAD

report reveals that between 1977 and 1987 both developed and developing

countries changed their respective tax subsidy policies in an attempt to entice

MNCs (Kebonang 2001). These changes in tax policy, although wasteful (as they

simply confer a windfall on MNCs), demonstrate clearly the importance countries

now attach to FDI.

The Dependency Theory.

Despite the centrality of FDI to Africa’s Economic growth and development,

enthusiasm about FDI is not widespread. Some commentators such as Bond

(2002) and Tandon (2002) among others have either impliedly or expressly

questioned the need for FDI. Bond (2002) sees for instance, multinational

corporations as agents of 'global apartheid' responsible for Africa's worsening

economic state, whilst Tandon (2002) argues that what Africa needs is 'self-

reliance and not FDI reliance'. The above views, which implicitly suggest that

FDI is exploitative, find sympathy in the dependency theory of FDI. Drawing

40

from the experience of Latin American countries, proponents of this theory argue

that relations of free trade and foreign investment with the industrialized countries

are the main causes of underdevelopment and exploitation of developing

economies (Wilhelms and Witter 1998). This theory focuses largely on the

relationship between the center and periphery. Well-developed and industrialized

countries are deemed to constitute the center and the least developed countries the

periphery. In this regard, FDI is seen as a conduit through which the center

exploits the periphery and perpetuates the latter's state of underdevelopment and

dependence.

Instead of promoting economic development, the argument goes; foreign

investment strangulates such development and perpetuates the domination of the

weaker states by keeping them in a position of permanent and constant

dependence on the economies of the developed states (Sornarajah 1994). MNCs

are accused of being "imperialist predators' that exploit developing countries and

exacerbate their underdevelopment (Alfaro 2003). These views are largely

informed by the fact that multinationals have often been involved in the

exploitation of natural resources with no corresponding benefits for host

economies (UNCTAD 1999). The dependency theory is therefore very much a

reaction against this "extractive nature" of FDI.

Under the dependency theory, FDI is considered to promote dependence and

underdevelopment through its promotion of specialization in production and

exports of primary products; increased reliance by least developed countries

(LDCs) on foreign products and capital intensive technology; diffusion of western

41

values and elite consumption; acute growth inequality in income distribution and

rising unemployment and destruction of indigenous production capacity (Gorg

and Strobl 2002; Girma and Wakelin 2000). The crowding-out or displacement of

indigenous production necessarily eliminates the development of the national

entrepreneurial class and hence "excludes the possibility of self-sustained national

development" (Biersteker 1978). This dependency is also worsened by the

remittance or repatriation of profit, royalties, interest payments, declining

reinvestment and lack of local economic spin-off, which taken together lead to a

'decapitalization' of the host economy (Rojas 2002).

These surplus transfers reduce funds available for domestic investment in the less

developed countries (Rojas 2002). As a result developing countries are compelled

to seek new forms of foreign financing--be it in the form of aid or loans to finance

their development or cover existing deficits, in the process they create a perpetual

state of dependency (Dos Santos 1970). Accordingly to address this problem, the

dependency theorists contend that the solution to underdevelopment requires

closing developing countries to international investment and trade (Wilhelm and

Witter 1998). Because of the perceived exploitative nature of FDI, the

dependency and underdevelopment it engenders, proponents of the dependency

theory are in unison in calling for the adoption of state policies that are

deliberately discriminative of FDI in order to foster the development of local

industries and promote self-reliance. Only by this means, so they contend, can

developing countries or governments acquire the autonomy and freedom to

42

achieve structural changes and economic diversification free from constraints on

their development (Blumenfeld 1991).

Despite its near reverence especially in the 1960s and 70s, the theoretical

dominance of the dependency theory over state policies has become limited. More

countries are now competing for FDI to stimulate economic growth and

development. Governments which were once hostile to foreign investors are now

actively seeking and competing for them. Laws and regulations that are investor

friendly have proliferated. Between 1991 and 2001, for instance, a total of 1,393

regulatory changes were introduced in national FDI regimes, of which 1,315 (or

95 percent) were in the direction of creating a more favorable environment for

FDI (World Bank 2003). Countries, such as Ghana, that once experimented with

the dependency theory have achieved neither prosperity nor greater economic

independence. Rather they have experienced much poverty, misery and greater

dependence on international aid and charity (Ahiakpor 1985).

The Middle-Path Theory.

The intervention or integrative school (the middle path theory) attempts to

analyze FDI from the perspective of the host country as well as that of the

investor. It incorporates arguments from both the classical and dependency

theorists. The theory posits that foreign investment must be protected but only to

the extent of the benefits it brings the host state and the extent to which foreign

investors have behaved as good corporate citizens in promoting the economic and

social objectives of the host country (Sornarajah 1994). The theory calls for a

mixture of intervention (regulation) and openness in dealing with foreign

43

investment and cautions against too much openness and too much regulation or

intervention (Seid 2002). The theory recognizes that there are instances where the

market is better placed to act and other instances where government intervention

is necessary. What is needed therefore is a balancing act between those activities

that can best be handled by the market and those that can be done by the

government.

The notion that governments and markets are complements and not substitutes

stands in stark contrast to earlier views which held the position that the existence

of one required the diminution of the other. In the 1950s and 1960s, the state in

many developing countries was the primary player in economic matters (Rodrik

1997). Following the debt crisis of the 1980s, major reforms were introduced

which sought to limit and confine the role of government to the provision of

public goods such as securing property rights, maintaining macroeconomic

stability and providing education and the necessary infrastructure (Rodrik 1997).

This idea of a limited government role in the market, often dubbed the

"Washington Consensus", was and has been actively promoted by the World

Bank and IMF.

The term 'Washington Consensus', coined originally in 1990 by John Williamson to describe a set of market reforms that Latin American economies could adopt to attract private capital following the debt crisis of the 1980s, called for reforms in at least ten key areas (Clift 2003; Williamson 2000). These areas were fiscal discipline, tax reform, interest rate liberalization, a competitive exchange rate, trade liberalization, a reduction of public expenditure, liberalization of inflows of foreign direct investment, privatization, deregulation and secure property rights (Maxwell 2005; Williamson 2000:252-53; Clift 2003:9). In essence, these reforms require the state, beyond its provision of the

44

necessary market institutions, to play a minimal role in the market. Although initially targeted at Latin American countries, these reforms have become a common prescription that is advanced by the World Bank/IMF for developing countries.

Ironically, even as it acknowledged the complementary roles between the state

and markets in promoting economic growth, the World Bank maintained in its

1991 Development Report that state interventions even when market-friendly

should be reluctantly pursued. Markets were to be allowed to work unless it was

demonstrably better for government to step in (World Bank 1991). Although

important, the state's role in economic development in this 'market-friendly'

approach is to be limited to providing social, legal and economic infrastructure

and to creating a suitable climate for private enterprise (Singh 1994). This

"market-friendly" approach, which requires a limited government role has been

found wanting following the East Asian economic success or miracle.

In its 1993 Report, the World Bank acknowledged that the economic success of

East Asian countries, particularly Hong Kong, South Korea, Singapore and

Taiwan, came not simply because these countries had the basics right (stable

macroeconomic policy, high savings rates and investment rates, physical and

human capital, economies that were export oriented, and the use of incentives and

application of selective import barriers) but because in most of these economies

the government intervened systematically and through many channels to foster

development and in some cases to develop specific industries (World Bank 1993)

Markets failures notwithstanding, government interventions may also be

inefficient. As Whiteley (1986) remarks, a state can intervene in the economy to

45

make things worse; it can protect 'sunset' industries rather than 'sunrise' industries;

it can give monopolistic privileges to support groups and it can invest in the

wrong areas, where state capacity is weak, state intervention can do more harm

than good (World Bank 1997). A study by Papanek (1992) found, for instance,

that excessive state intervention in the economies of India, Pakistan, Sri Lanka

and Bangladesh deterred economic growth and development in these countries.

46

2.4.2 FDI CONSTRAINTS IN AFRICA.

Various explanations have been adduced for Africa’s poor FDI record. In the

empirical literature, the following factors are important determinants of FDI flows

to the region.

Political instability. The region is politically unstable because of the high incidence of wars, frequent

military interventions in politics, and religious and ethnic conflicts. There is some

evidence that the probability of war––a measure of instability––is very high in the

region. In a recent study, Rogoff and Reinhart (2003) computed regional

susceptibility to war indices for the period 1960-2001. They found that wars are

more likely to occur in Africa than in other regions. The regional susceptibility to

war index is 26.3% for Africa compared to 19.4% and 9.9% for Asia and the

Western Hemisphere respectively. The study also showed that there is a

statistically significant negative correlation between FDI and conflicts in Africa.

Sachs and Sievers (1998) have also argued that political stability is one of the

most important determinants of FDI in Africa.

Macroeconomic instability. Instability in macroeconomic variables as evidenced by the high incidence of

currency crashes, double digit inflation, and excessive budget deficits, has also

limited the regions ability to attract foreign investment. Recent evidence based on

African data suggests that countries with high inflation tend to attract less FDI

(Onyeiwu and Shrestha, 2004).

47

Lack of policy transparency. In several African countries it is often difficult to tell what specific aspects of

government policies are. This is due in part to the high frequency of government

as well as policy changes in the region and the lack of transparency in

macroeconomic policy. The lack of transparency in economic policy is of concern

because it increases transaction costs thereby reducing the incentives for foreign

investment.

Inhospitable regulatory environment. The lack of a favourable investment climate also contributed to the low FDI trend

observed in the region. In the past, domestic investment policies––for example on

profit repatriation as well as on entry into some sectors of the economy––were not

conducive to the attraction of FDI (Basu and Srinivasan, 2002). Costs of entry, as

a percentage of 1997 GDP per capita, are very high in Africa relative to Asia.

Within Africa, the costs are higher in Burkina Faso (133.4%), Senegal

(99.6%), Nigeria (99.3%), and Tanzania (86.8%).

GDP growth and market size.

Relative to several regions of the world, growth rates of real per capita output in

Africa are low and domestic markets are quite small. This makes it difficult for

foreign firms to exploit economies of scale and so discourages entry. Elbadawi

and Mwega (1997), show that economic growth is an important determinant of

FDI flows to the region.

48

Poor infrastructure. The absence of adequate supporting infrastructure: telecommunication; transport;

power supply; skilled labour, discourage foreign investment because it increases

transaction costs. Furthermore poor infrastructure reduces the productivity of

investments thereby discouraging inflows. Asiedu (2002b) and Morrisset (2000)

provide evidence that good infrastructure has a positive impact on FDI flows to

Africa. However, Onyeiwu and Shrestha (2004) find no evidence that

infrastructure has any impact on FDI flows to Africa.

High protectionism. The low integration of Africa into the global economy as well as the high degree

of barriers to trade and foreign investment has also been identified as a constraint

to boosting FDI to the region. Bhattachrya, Montiel and Sharma (1997) and

Morrisset (2000) argue that there is a positive relationship between openness and

FDI flows to Africa.

Other factors that account for the low FDI flows to the region but are rarely

included in empirical

studies––presumably due to data limitations–– include:

High dependence on commodities. Several African countries rely on the export of a few primary commodities for

foreign exchange earnings. Because the prices of these commodities are highly

49

volatile, they are highly vulnerable to terms of trade shocks, which results in high

country risk thereby discouraging foreign investment.

Increased competition. Globalization has led to an increase in competition for FDI among developing

countries thereby making it even more difficult for African countries to attract

new investment flows. Relative to other regions of the world, Africa is regarded

as a high-risk area. Consequently foreign investors are reluctant to make new

investments in––or move existing investments to––the region. The intensification

of competition due to globalization has made an already bad situation worse. It

must be pointed out that the intense competition resulting from trade and financial

liberalization puts African countries at a disadvantage because they have failed to

take advantage of the globalization process––for example, through deepening

economic reforms needed to increase their competitiveness and create a

supportive environment for foreign investment.

Corruption and weak governance. Weak law enforcement stemming from corruption and the lack of a credible

mechanism for the protection of property rights are possible deterrents to FDI in

the region. Foreign investors prefer to make investments in countries with very

good legal and judicial systems to guarantee the security of their investments.

2.5 FDI IN NIGERIA.

Brief Introduction.

50

The role of foreign direct investment in the development of Nigerian economy

cannot be over emphasized. Foreign direct investment (FDI) not only provides

developing countries (including Nigeria) with the much needed capital for

investment, it also enhances job creation, managerial skills as well as transfer of

technology. All of these contribute to economic growth and development. To this

end, Nigerian authorities have been trying to attract FDI via various reforms. The

reforms included the deregulation of the economy, the new industrial policy of

1989, the establishment of the Nigeria Investment Promotion Commission (NIPC)

in 1995, and the signing of Bilateral Investment Treaties (BITs) in the late 1990s.

Others were the establishment of the Economic and Financial Crime Commission

(EFCC) and the Independent Corrupt Practices Commission (ICPC). Before

transitioning to democracy in 1999, Nigeria had been experiencing declining and

fluctuating foreign investment inflows. Besides, Nigeria alone cannot provide all

the funds needed to invest in various sectors of the economy, to make it one of the

twenty largest economies in the world by 2020 and to meet the Millennium

Development Goals (MDGs) in 2015.

Economic Backdrop.

At independence, in addition to being a leading exporter of groundnut, Nigeria

accounted of 16 and 43 percent of world cocoa and oil-palm respectively. The

country was largely self-sufficient in terms of domestic food production (85%)

and Nigerian agriculture contributed to over 60 percent of GDP and 90 percent of

exports. Conversely, manufacturing was less than 3percent of GDP and 1 percent

of exports, while the oil sector represented only 0.2 percent of GDP.

51

At this time, foreign presence in the economy was significant. More than 25

percent of companies registered in Nigeria in 1956 were foreign-owned while in

1963 as much as 70 percent of investment in the manufacturing sector was from

foreign sources (ohiorhenuan, 1990). Most FDI was from the Middle East and the

United-Kingdom and concentrated on commerce and cash-crops.

The First National Development Plan (1962-1968) sought to broaden the base of

the economy and limit the risk of over-dependence of foreign trade (okigbo,

1990). In keeping with developmental rhetoric of that era, the tariff structure was

formulated with industralisation and import substitution in mind. Manufacturing

initially responded albeit slowly to the new policy but with foreign exchange and

import licensing controls introduced in 1971-72, the progress halted.

In addition to industrialization, removing of the dominance of foreign entities in

the Nigerian economic landscape was of major public concern. Legislation that

signified economic independence through nationalization of assets and state led

investment in public institutions was adopted.

The second National Development Plan (1970-1974) accelerated indigenization

on grounds that it was vital for Government to acquire, by law if necessary, the

greater proportion of the productive assets of the economy. Restrictions were

therefore imposed on the activities of foreign investors with the first

indigenization decree adopted in 1972. Further restrictions were imposed in the

second indigenization decree in 1977. The result has been described as among the

most comprehensive joint venture schemes in Africa and the developing world at

52

large (Biersteker, 1987). The numbers of activities reserved exclusively for

Nigerians were expanded to include a wide range of basic manufactures. Foreign

firms were compelled to enter into joint ventures with local capitals or the state.

Many foreign investors-such as IBM, Chase Manhattan Bank and Citigroup-

divested during this period.

The third National Development Plan (1975 -1980) was framed after the world

price of crude oil quadrupled (1973) and the share of oil in total exports reached 90

per cent. In this setting, exchange controls were reduced and restrictions on import

payments abandoned. Public expenditure increased sharply and the Naira

appreciated, further eroding agricultural competitiveness. Additional incentives

for industrialization were adopted, including pioneer status and fast depreciation

allowance on capital goods. These incentives produced a temporary increase in

manufacturing output, which grew on average 14 per cent per annum between

1975 and 1980, compared to 6 per cent in services. On the other hand,

agriculture production shrank by 2 per cent annually over the same period.

Following the major decline of oil prices in the early 1980s, the shortcomings of past

economic planning were exposed. Agriculture accounted for less than 10 per cent of

exports and the country had become a net food importer. Manufacturing output

started falling at about 2 per cent per annum between 1982 and 1986 while GDP

stagnated, with less than 1 per cent growth annually. Furthermore, by 1986, there

were about 1,500 State-owned enterprises, of which 600 were under the control of

the federal Government and the remainder under State and local Governments.

53

The evidence suggests that many made no contribution to Nigeria’s productive

capacities and many enterprises were not financially viable (Mahmoud, 2004).

The cumulative effect of these policies is that Nigeria has not undergone

fundamental structural change experienced by other developing countries in the

last 40 years. Manufacturing still reperesents only 4% of GDP compared with 14%

around the rest of sub-saharan Africa. Maintenance spending are at levels close to

zero leading to a sharp deterioration in water supply, sewage, sanitation, drainage,

roads and electricity infrastructure (Worldbank 1996). Hence, the misallocation of

public finances has taken a heavy toll on the state of basic infrastructure.

In order to restore economic prosperity and address external shocks such as the

global recession of the early 1980s, the Government initiated a series of austerity

measures and stabilization initiatives in 1981- 1982. These, however, proved

unsuccessful and a structural adjustment programme (SAP) followed. The SAP

(1986 -1988), which emphasized privatization, market liberalization and

agricultural exports orientation, was not implemented consistently and was at odds

with other facets of policy, e.g. tariff increases. But an economic reform process,

which continues to the present, has it origins in this period. Following the return

to democracy in May 1999, the reform process was re-energized, mainly through

Nigeria’s home-grown poverty reduction strategy. The National Economic

Empowerment and Development Strategy (NEEDS), adopted in 2003, and was

followed a highly participatory process as important stake-holders such as the

private sector have been carried along. Associated poverty reduction strategies

were developed at the State and local levels - State Economic Empowerment and

54

Development Strategies (SEEDS) and Local Economic Empowerment and

Development Strategies (LEEDS).

NEEDS, SEEDS and LEEDS were major departures from the policies of the past.

Their broad agenda of social and economic reforms was based on four key strategies

to:

• Reform the way government works in order to improve efficiency in delivering services, eliminate waste and free up resources for investment in infrastructure and social services.

• Make the private sector the main driver of economic growth by turning the government into a business regulator and facilitator.

• Implement a social charter which include improving security, welfare and participation and

• Push a value-re-orientation by shrinking the domain of the state and hence the pie of distributable rents which have been the haven of public sector corruption and inefficiency.

In contrast with previous development plans, NEEDS made FDI attraction an

explicit goal for the Government and paid particular attention to drawing

investment from wealthy Nigerians abroad and from Africans in the Diaspora.

55

2.5.1 FDI ORIGIN IN NIGERIA

The oil industry has been the largest single beneficiary of FDI in Nigeria.

Companies such as Exxon-Mobil (U.S.A), Shell (Dutch), Total (French) e.t.c. are

some of the biggest players in the Nigerian Oil industry. However, Chinese

investments are increasing in Nigeria across sectors. In Africa, South-African

investments are on the rise. Companies such as Multi-choice, True love magazine,

and MTN in mobile telecommunications are examples of firms originating from

south-Africa. Also, from the Middle-East we have Etisalat and Bharti-Airtel (the

new owners of Zain)

Nigeria’s economy is similar in several respects to other low income developing

economies in Africa but is significantly different in its considerable oil and gas

resource base and the large size of the domestic market. In contrast to other large

oil producers, Nigeria has not managed to use oil resources to diversify its

economy and move towards higher productivity sectors. The advantage of a

relatively large domestic market has not delivered efficiency gains for domestic

firms. We will examine the impact of FDI in three important sectors of the

Nigerian economy, namely oil, manufacturing and telecommunications.

The economy is dominated by oil which has risen in importance from 29 percent

of GDP in 1980 to 52 percent in 2005. Oil and gas contribute about 99 percent of

exports and provide about 85 percent of government revenues however its

contribution to employment is limited—estimated at around 4 percent. Public

ownership of oil has also allowed extension of the public sector evidenced in

historically much higher share of government spending in GDP than in other

56

developing countries. Direct foreign investment has been instrumental in the

development of oil extraction to a point where Nigeria is now the 11th largest oil

producer in the world and the largest in Africa. MNCs have been able to deploy

capital and technology on a scale beyond Nigeria’s domestic resources. They have

been especially significant in exploration and extraction from difficult areas, such

as deepwater reserves in the Gulf of Guinea. However, FDI has not been prominent

in the downstream side of the oil industry. For example, Nigeria imports refined

products accounting for 21 percent of total imports.

FDI has not shown real impact on the development of Nigeria’s manufacturing

sector. The industry has stagnated over a period of 30 years either due to

inhospitable business environment or dilapidated infrastructure. Manufacturing

exports have revived since the 1990s. But they are not appreciably greater now

than in 1965 (in constant United States dollars) and have halved on a per capita

basis. In comparative terms, exports per capita in 2003 were $493 in South Africa,

$59 in Egypt, $24 in Kenya and $3 in Nigeria for the same group of manufactures.

The manufacturing sector is similarly strongly oriented towards food and

beverages for the domestic market, accounting for between 50- 60 percent of

manufacturing GDP. The largest component of the services sector is wholesale

and retail trade, of which food and beverages represent close to 90 percent, with

domestically produced food and beverages accounting for the overwhelming

proportion of value added. Food and beverages therefore account for between 50-

60 percent of

non-oil GDP.

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FDI has had a notable impact on the expansion of mobile telephony in Nigeria

since the launch of Global System for Mobile (GSM) licensing in January 2001.

Two of the three licenses issued went to foreign companies- MTN of South Africa

and Econet Wireless (Now Zain Nigeria) for $285 million each, a year later

globacom, Nigeria’s second national carrier was granted license. The impact of

FDI under competitive conditions in mobile telephony has been remarkable. In

the sector as a whole, subscriber numbers have grown from 35,000 to over 16

million by September 2005. Prior to the licensing of the Digital Mobile Operators,

private investment in the telecommunications sector was just about US$50

million. Between 2001 and now, the sector has attracted over US$9.5 Billion,

substantial part of which are direct foreign investment. Nigeria has thus become

one of the most desired investment destinations for ICT in Africa. In addition to

this, the Federal government has earned over US$2.5 Billion from Spectrum

licensing fees alone between 2001 and now. Import duties and taxes from the

telecom industry have also contributed substantial revenue to the Federal

Government.

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2.5.3 FDI PROMOTION IN NIGERIA.

Privatisation.

Privatisation has also become an important source of FDI over the last two

decades. Nigeria has implemented two rounds of privatization since the 1980’s-

the first one (1986-1993) as part of the structural adjustment programme and the

second one since the return to democracy in 1999.

During the first privatization wave, foreign investors were excluded from bidding

in all sectors except oil. This was effectively the last major expression of the

indigenization policy. The sale of oil interests to Elf Aquitaine for $500 million

in 1992, however, represented almost two thirds of the total proceeds from

privatization ($740 million).

In contrast, the second privatization wave, originally scheduled to last from 1999

to the end of 2003, focused on attracting foreign investment. By then, the 1995

landmark NIPC decree was in place. Almost 100 enterprises were targeted for

privatization or commercialization in three phases.

There are indications that FDI inflows to sectors other than oil and gas are reacting

positively to the various reforms to the investment climate carried out since 1999.

Several non-oil sector MNCs have expanded production in Nigeria. For example,

Heineken invested 250 million Euros in purchasing and expanding Nigeria

Breweries in 2004. MTN, the largest mobile telephony operator in Nigeria, has

invested over $3 billion in the sector between 2001 and 2006, and has expressed

commitment to ongoing expansion.

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Establishment of Free Trade Zones

As part of initiatives to promote FDI in Nigeria the Nigerian Free Zone Act

(1992) was passed establishing the Nigerian Export Processing Zone Authority

(NEPZA). Free trade zones (FTZ), so renamed in 2001, are expanses of land with

improved ports and/or transportation, warehousing facilities, uninterrupted

electricity and water supplies, advanced telecommunications services and other

amenities to accommodate business operations. Under the free zone system, as

long as end products are exported (although 25% can be sold in the domestic

market), enterprises are exempt from customs duties, local taxes, and foreign

exchange restrictions, and qualify for incentives—tax holidays, rent-free land, no

strikes or lockouts, no quotas in EU and US markets, and, under the 2000 African

Growth and Opportunity Act (AGOA), preferential tariffs in the US market until

2008. When fully developed, free zones are to encompass industrial production,

offshore banking, insurance and reinsurance, international stock, commodities,

and mercantile exchanges, agro-allied industry, mineral processing, and

international tourist facilities.

As of 2003, Nigeria had five free trade zones (FTZs) being developed. The most

advanced is the Calabar FTZ in the southeast; established in 1992 with

accommodations for 80 to 100 businesses, it had only 6 companies in 2001. By

May 2003, however, 76 licenses had been issued for the Calabar FTZ and 53

enterprises were operating. The Calabar harbor, which was scheduled for further

dredging, serves mainly as a berthing port for textile and pharmaceutical products.

The Onne Oil and Gas FTZ near Port Harcourt had about 85 registered oil and gas

60

related enterprises, and was generating about $1.2 million in government revenue

annually. The other three FTZs—at Kano, Maigatari, and Banki—were still at the

stage of infrastructure construction. Under the related Export Processing Zones

(EPZ) initiative 7 factory sites in Ondo, Akwa-Ibom and Kano states, with

another 12 under construction in Lagos, have received infrastructure

improvements, tax exemptions, and incentives to reduce their production costs in

order to make their exports more competitive. There are also five export-

processing farms (EPFs), selected for their export potential to receive site

improvements, exemptions, and incentives. Finally, Singaporean interests have

spent about $169 million developing the private Lekki FTZ.

Nigeria's FTZ regulatory regime is liberal and provides a conducive environment

for profitable operations. The incentives available are among the most attractive

in Africa and compares favourably with those in other parts of the world. These

include:

• Exemption from all federal, state and local government taxes, levies and rates.

• Approved enterprises shall be entitled to import into a zone, free of

customs duty on capital goods, consumer goods, raw materials, components and articles intended to be used for purposes of and in connection with an approved activity.

• Freedom from legislative provision pertaining to taxes, levies, duties and

foreign exchange regulations.

• Repatriation of foreign capital on investment in the zone at any time with capital appreciation of the investment.

• 100% foreign or local ownership of factory allowable.

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• One stop approvals which grant all licenses whether or not the business is incorporated in the Customs Territory.

• Unrestricted remittance of profits earned by investors.

• Permission to sell 100% of total production in the domestic market.

• No import or export license.

• Rent free land at construction stage, thereafter rent shall be as determined

by the management of the zone. Foreign managers and qualified personnel may be employed by companies operating in the zones.

2.5.4 FDI BENEFITS IN NIGERIA

In its base document, the New Partnership for Africa's Development (NEPAD)

emphasizes the importance of Foreign Direct Investment (FDI) to Africa's long-term

development. Aaron (1999) provides evidence on the positive impact of FDI on

employment in developing countries.

Employment generation and growth

By providing additional capital to a host country, FDI can create new employment

opportunities resulting in higher growth. It can also increase employment

indirectly through increased linkages with domestic firms.

Supplementing domestic savings.

African countries have low savings rates thereby making it difficult to finance

investment projects needed for accelerated growth and development. Available

data indicate that in Sub-Saharan Africa gross domestic savings as a percentage of

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GDP fell from 21.3% over the period 1975-84 to 17.4% in the period 1995-2002.

Furthermore, the gap between domestic savings and investment was -1.9% of

GDP over the period 1975-84 and -1.0% of GDP during the period 1995-2002.

FDI can fill this resource gap between domestic savings and investment

requirements. Integration into the global economy: Openness to FDI enhances

international trade thereby contributing to the integration of the host-country into

the world economy (Morrisset, 2000).

Raising skills of local manpower.

Through training of workers and learning by doing, FDI raises the skills of local

manpower thereby increasing their productivity level. The idea that FDI enhances

the productivity of the labour force is supported by empirical evidence suggesting

that workers in foreign-owned enterprises are more productive than those in

domestic-owned enterprises (Harrison,1996).

Transfer of modern technologies.

Foreign firms typically make significant investments in research and

development. Consequently they tend to have superior technology relative to

firms in developing countries. FDI gives developing countries cheap access to

new technologies and skills thereby enhancing local technological capabilities and

their ability to compete on world markets. Blomstrom and Kokko (1998) provide

an interesting survey of the literature on FDI and transfer of technology.

63

Enhanced efficiency.

Opening up an economy to foreign firms increases the degree of competition in

product markets thereby forcing domestic firms to allocate and use resources

more efficiently.

2.6 DETERMINANTS OF FDI FLOWS Earlier theoretical and empirical studies on FDI have adopted either one or a

combination of two approaches. The first or the ‘pull-factor’ approach examines

the relationship between host-country specific conditions and the inflow of FDI.

Under this approach FDI is either classified as (i) import-substituting; (ii) export-

increasing or (iii) government-initiated (Moosa 2002). The second or the ‘push-

factor’ approach leans towards examining the key factors that could influence or

motivate multinational corporations (MNCs) to want to expand their operations

overseas. Under this second approach, FDI is either classified as horizontal or

market seeking, vertical or conglomerate (Caves 1971, 1974; Moosa 2002). Some

factors that attract FDI as empirically validated include:

Return on Investment in the Host Country. The profitability of investment is one of the major determinants of investment.

Thus the rate of return on investment in a host economy influences the investment

decision. Following previous studies (see Asiedu, 2002), the log of inverse per

capita has been used as proxy for the rate of return on investment as capital scarce

countries generally have a higher rate of return, implying low per capita GDP.

64

This implies that the lower the GDP per capita, the higher the rate of return and

thus FDI inflow.

Relative Size of market and growth. The aim of FDI in emerging developing countries is to tap the domestic market,

and thus market size does matter for domestic market oriented FDI. Econometric

studies comparing a cross section of countries indicate a well-established

correlation between FDI and the size of the market (proxied by the size of GDP),

average income levels and growth rates. The size of the market or per capita

income are indicators of the sophistication and breath of the domestic market.

Thus, an economy with a large market size (along with other factors) should

attract more FDI. The prospect of growth also has a positive influence on FDI

inflows. Countries that have high and sustained growth rates receive more FDI

flows than volatile economies. There are good number of studies showing the

positive impact of per capita growth or growth prospect on FDI (Schneider and

Frey, 1985; Lipsey,1999; Dasgupta and Rath, 2000; and Durham, 2002).

Openness and export promotion. The key hypothesis from various theories is that gains from FDI are far higher in

the export promotion (EP) regime than the import promotion regime. The theory

proposes that import substitution (IS) regimes encourage FDI to enter in cases

where the host country does not have advantages leading to extra profit and rent-

seeking activities. However in an EP regime, FDI uses low labor costs and

available raw materials for export promotion, leading to overall output growth.

The ratio of trade (imports + exports) to GDP is often used as a measure of

65

openness of an economy. This ratio is also often interpreted as a measure of trade

restrictions. A range of surveys suggests a widespread perception that `open'

economies encourage more foreign investment. Trade openness generally

positively influences the export-oriented FDI inflow into an economy (Housmann

and Fernandez-arias (2000), Asidu (2001)). Overall, the empirical literature

reveals that one of the important factors for attracting FDI is trade policy reform

in the host country. Investors generally want big markets and like to invest in

countries which have regional trade integration, and also in countries where there

are greater investment provisions in their trade agreements. Excessive trade

liberalization in the host country may induce MNCs to export to that market

instead of producing there. Import liberalization may also however stimulate

competition, thereby encouraging foreign firms to transfer technology to their

affiliates in the liberal market to maintain competitiveness Blomström et al.

Labour costs and productivity. Cheap labor is another important determinant of FDI inflow to developing

countries. A high wage-adjusted productivity of labor attracts efficiency-seeking

FDI both aiming to produce for the host economy as well as for export from host

countries. Empirical research has also found relative labour costs to be

statistically significant, particularly for foreign investment in labour-intensive

industries (the use of unskilled labour is prevalent) and for export- oriented

subsidiaries. The decision to invest in China, for example, has been heavily

influenced by the prevailing low wage rate.

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Financial Sector development.

Well-developed domestic financial markets are instrumental in efficiently

allocating foreign financial flows, including FDI, to competing investment

projects (see Aoki et al., 2006). Deep domestic financial markets can also provide

the necessary credit to local firms when they need financing to take advantage of

technological spillovers associated with FDI (Alfaro et al, 2004).

Political Risk

The ranking of political risk, among FDI determinants remains unclear. Where the

host country possesses abundant natural resources, no further incentive may be

required, as is seen in politically unstable countries such as Nigeria and Angola,

where high returns in the extractive industries seem to compensate for

Institutional Quality and Infrastructure. The quality of institutions is likely an important determinant of FDI activity,

particularly for less-developed countries for a variety of reasons. First, poor legal

protection of assets increases the chance of expropriation of a firm’s assets

making investment less likely. Poor quality of institutions necessary for well-

functioning markets (and/or corruption) increases the cost of doing business and,

thus, should also diminish FDI activity. Corruption in the FDI recipient countries

can be measured in a variety of ways. These include: a rating by Transparency

International, which is a global non-governmental organization devoted to fight

67

corruption; a measure derived from a survey of firms worldwide as published

jointly by Harvard University and the World Economic Forum in the Global

Competitiveness Report; and a measure from a survey of firms worldwide

conducted by the World Bank. The results from these different measures are quite

consistent; all show a negative effect of corruption on the volume of inward

foreign direct investment. And finally, to the extent that poor institutions lead to

poor infrastructure (i.e., public goods), expected profitability falls as does FDI

into a market. Most measures are some composite index of a country’s political,

legal and economic institutions (proxied by the International Country Risk Guide

(ICRG) index of institutional quality). Furthermore, the availability of quality

infrastructure, particularly electricity, water, transportation and

telecommunications, is an important determinant of FDI. When developing

countries compete for FDI, the country that is best prepared to address

infrastructure bottlenecks will secure a greater amount of FDI.

Exchange rates.

The exchange rate is an important relative price as is has influence on the external

competitiveness of domestic goods and on lowering production costs by MNCs. If

capital stock is optimal,a real depreciation of the exchange rate will result in a

decline in domestic investment and a cheaper purchase of assets and technology

by the foreign firms thereby increasing FDI. On the contrary, a decrease in the

exchange rate, meaning an appreciation, would imply more foreign currency

earnings for the foreign investors hence would increase FDI inflow.

Inflation .

68

High inflation rate is expected to have negative impacts on FDI flows. This is as a

result of unstable macroeconomic policies and conditions adversely affecting

expectations and investment decisions of entrepreneurs. According to Onyeiwu

and Shrestha (2004), high inflation could also increase the cost of capital which

would in turn affect profitability of FDI.

Government finance. Government finance is an important issue that affects capital flows. A high fiscal

deficit leads to more government liabilities and therefore more taxes and defaults

on international debt. Therefore, fiscal stability is generally considered to be one

of the indicators of macroeconomic stability. We consider the fiscal deficit for

government finance.

Corporate tax rates.

Source countries corporate tax rates influence the decision on whether to establish

a foreign affiliate but not its magnitude while tax rates of host countries affects

both the decisions and magnitude of FDI flows such that if a country’s tax rate is

sufficiently high and above that of the potential host country, then a firm may

decide to establish a foreign affiliate. Hence, the amount of production activity

transferred to the affiliate clearly depends on how high the host country’s

effective tax rate is. Onyeiwu and Shrestha (2004) argue that high levels of

taxation would discourage FDI whilst low levels of taxes would encourage

foreign investors; hence there is a negative relationship with FDI.

Policy measures.

69

Though investment incentives are considered another determinant for FDI, the

recent paper by Blomstrom and Kokko (2003) suggests that investment incentives

alone are generally not an efficient way to increase national welfare. Policies to

promote FDI take a variety of forms, but the most common are partial or complete

exemptions from corporate taxes and import duties. Standard policies to attract

FDI include tax holidays, import duty exemptions, and different kinds of direct

subsidies. FDI inflows are also affected by corporate tax rate differentiation.

Subsidizing FDI helps multinational firms reduce production costs, improves

incentives to create patents, trademarks, and enhances the relative attractiveness

of locating production facilities in the country offering incentives and raises the

economic benefits of FDI relative to exporting. Table 2.3 summarizes the benefits

of FDI under three categories; Economic conditions, Host-country policies and

MNC strategies.

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Table 2.3 determinants of foreign direct investment.

Economic Conditions

Markets

Size, income levels, urbanization, stability and growth prospects, access to regional markets, distribution and demand patterns;

Resources

Natural resource, location;

competitiveness Labour availability, cost, skills, trainability, managerial technical skills, access to inputs, physical infrastructure, supplier base, technology support;

Macro-policies

Management of crucial macro-variables,ease of remittance, access to foreign exchange;

Host Country Policies

Private Sector

Promotion of private ownership, clear and stable policies, easy entry/exit policies, efficient financial markets, other support;

Trade and industry

Trade Strategy; regional integration and access to markets; ownership controls; competition policies; support for SMEs

FDI Policies Ease of entry, ownership, incentives, access to inputs, transparent and stable policies;

Risk Perception Perceptions of country risk, based on political factors, macro management, labour markets, policy stability

MNC Strategies

Location, Sourcing, Integration, transfer;

Company strategies on location, sourcing of products/inputs, integration of affiliates, strategic alliances, training, technology

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CHAPTER THREE

THEORETICAL FRAMEWORK AND RESEARCH METHODOLOGY

3.1 INTRODUCTION The UNCTAD World Investment Report 2006 shows that FDI inflow to West Africa

is mainly dominated by inflow to Nigeria, who received 70% of the sub-regional total

and 11% of Africa’s total. Out of this Nigeria’s oil sector alone receive 90% of the

FDI inflow. This recent improved performance in FDI inflow to Nigeria calls for the

need to investigate the factors that determine its inflow. This study focuses on FDI

flow to Nigeria, which is poor in terms of income but rich in natural resources. How

important are the market size, macroeconomic instability, infrastructure and trade

policy like openness in the determination of FDI inflow to poor economy like

Nigeria?

3.2 SOURCES OF DATA

The data employed in this analysis shall be derived from the following sources:

The world-bank website (global development finance), Penn-World table 6.3, OPEC

(organization of petroleum exporting countries) website and the CBN statistitical

bulletin (2008). The variables used in this model are proxied by time series data and

they are of secondary nature as opposed to primary data. The time period for analysis

is between the years 1977 to 2008.

72

3.3 THEORETICAL FRAMEWORK

The extensive literature, based generally on three approaches – aggregate

econometric analysis, survey appraisal of foreign investors’ opinion and

econometric study at the industry level – has failed to arrive at a consensus. This

can be partly attributed to the lack of reliable data, particularly at the sectoral

level, and to the fact that most empirical work has analysed FDI determinants by

pooling of countries that may be structurally diverse. The absence of a generally

accepted theoretical framework has led researchers to rely on empirical evidence

for explaining the emergence of FDI. Although there has been considerable

theoretical work on foreign direct investment (see, e.g., Hymer, 1960; Caves,

1982; Buckley and Casson, 1976), there is no agreed model providing the basis

for empirical work. The theoretical literature is choked with an array of

hypotheses drawing heavily on theories of imperfect competition and market

failure to explain the FDI phenomenon. These hypotheses find their roots in

Hymer’s (1960) seminal work, refined and publicized by Kindleberger (1969), but

they emerged in a more consistent manner from Dunning’s “eclectic approach”.

Dunning’s (1974, 1980) OLI paradigm (ownership, location, internalization) has

provided a taxonomic framework for most estimating equations.

3.4 DESCRIPTION OF VARIABLES.

This study is an adaptation of the work of Obi and Nurudeen (2010) and Asiedu

(2004)which does not apply any specific FDI theory in investigating the

determinants of FDI in Nigeria.

73

The Independent variables used in this research are:

Market Size

Many studies have cited the host country’s market size (Proxied by GDP) as an

important determinant of FDI inflows (Masayuki and Ivohasina, 2005). However,

if the host country is only used as a production base due to low production costs

in order to export their products to another or home market, then the market size

may be less influential or insignificant (Agarwal,1980).

Exchange rate

If the exchange rate of a country depreciates, it attracts FDI since they affect a

firm’s cash flow, expected profitability and the attractiveness of domestic assets

to foreign investors (Erdal and Tatoglu 2002; Maniam 1998). Exchange rates are

expected to affect FDI inflows because Exchange rate fluctuations are used as a

measure of macroeconomic instability. The higher and more unstable it is, the less

FDI inflows into a host country. However, Benassy-Quere et al. (2001) disclosed

that the effects of the level of exchange rates on FDI inflows are rather

ambiguous.

Trade-Openness

The ratio of trade (imports + exports) to GDP is often used as a measure of

openness of an economy. This ratio is also often interpreted as a measure of

trade restrictions. A range of surveys suggests a widespread perception that

`open' economies encourage more foreign investment. Trade openness

74

generally positively influences the export-oriented FDI inflow into an economy

Housmann and Fernandez-arias (2000).

Infrastructure development Good infrastructure increases the productivity of investments and therefore

stimulates FDI flows. A good measure of infrastructure development should take

into account both the availability and reliability of infrastructure. I use Electricity

consumption (measured in Kilowatts-hour per capita) as a proxy variable to

represent availability of infrastructure in my model.

3.5 MODEL SPECIFICATION The equation to be estimated is:

FDI = (NGDP, EXR, TOPN, ELCON)

LnFDIit = β

0 + β

1 LnNGDP

it + β

2EXR

it + β

3TOPN

it + β

4ELCON

it + ε

it

Where βo, β1, β2, β3, β4, are coefficients of elasticities, Ln represents the

natural logarithm of variables, and ε the disturbance term.

Were LnFDI is the natural logarithm for foreign direct investment

LnNGDP is the natural logarithm of nominal values for GDP

EXR is the rate at which naira is converted to dollar

ELCON is electricity consumption.

Apriori Expectations

75

On the basis of the above theoretical consideration the following provides a

summary of the expected relationships between the explanatory variables

considered in the model and the level of foreign direct investment in the Nigerian

Economy.

β0 > 0; β

1 > 0; β

2 < 0; β

3> 0; β

4 > 0

3.6 ESTIMATION TECHNIQUES

Coefficient of determination (R2):

The R2 is a descriptive statistic. In general a high value of R2 is associated with a

good fit of the regression line, and a low value of R2 with a poor fit. It is a

measure of the degree to which variations in the dependent variable are explained

by variations in the explanatory variables. It takes values between zero and one,

i.e. 0<R2<1. It is useful as it provides an initial measure of the confidence of our

forecast.

Adjusted R-square (R2):

This shows the total percentage of variation in the dependent variable after

necessary adjustment has been made for the number of explanatory variables. It

provides a better measure of the degree of variation in the dependent variable.

Durbin-Watson Test:

When the error term in one time period is positively correlated with the error term

in another time period, we face the problem of positive first-order autocorrelation.

The decision rule for the DW statistics is if there is no auto correlation, then d = 2.

76

Likewise if d = 0, we have a perfect positive auto correlation. However, if 0 < d <

2, then there is some degree of positive auto correlation (which is stronger if d is

closer to zero)

F- statistic.

It is used to test for the overall significance of the model. If the F-calculated is

greater than the critical F-statistic, at the specified level of significance (5%) and

degrees of freedom, we reject the null hypothesis of no linear relationship

between dependent and independent variables at the 5% level of significance. The

F statistic and its significance enable us to make a categorical statement about our

estimated model and its related R2 is significant or whether it occurred merely as

a chance event.

Decision Rule:

H0 : β1 = β2 = β3 = β4 = 0 i.e. No linear relationship between FDI and the

explanatory variables

H1 : β1 = β2 = β3 = β4 ≠ 0 i.e. there is a linear relationship between FDI and the

explanatory variables

Student’s T-Test (The p-value):

It is used to test for the statistical significance of the parameters (in this case β1,

β2, β3, β4

). For example, we set the following null hypothesis

H0 : β1 = 0 H1 : β1 ≠ 0

77

When using sophisticated software such as E-views we compare the p-values with

the significance level. The p-value is the smallest significance level at which the

null hypothesis would be rejected. The p-value nicely summarizes the strength or

weakness of the empirical evidence against the null hypothesis. This means that

small p-values are evidence against the null; large p-values provide little evidence

against H0. Because a p-value is a probability, its value is always between zero

and one, i.e. 0< p < 1.

Unit Root Test (Augumented Dickey-fuller test)

This is used to test for stationarity in the explanatory variables. Variables can be

stationary at level, first difference or second difference. This is to make sure that

the data used is not spurious.

78

CHAPTER FOUR

DATA PRESENTATION & ANALYSIS OF RESULT

4.1INTRODUCTION

The model for this work was specified in the immediate chapter in line with the

tradition of econometrics using ordinary least squares (OLS). The adequacy of the

ordinary least square estimation method depends on the attainment of the so

called BLUE properties which stipulates that the estimators of the regression

equation must be unbiased, efficient, consistent (or asymptotically efficient) and a

linear function of the disturbance term (u).

Assumptions of the OLS Model

The random error term µ is normally distributed.

• The expected value of the error term (µ) is zero. i.e. E(µ)=0.

• The variance of the error term is constant in each period and for all values

of the explanatory variable;

• The value which the error term assumes in one period is uncorrelated to its

value in any other period

• The explanatory variable assumes fixed values that can be obtained in

repeated samples, so that the explanatory variable is also uncorrelated with

the error term.

79

4.2 TREND ANALYSIS OF FDI IN NIGERIA

In the 1970s, FDI had been in a steady decline due to the enforcement of the

indegenisation decrees (1972,1977). FDI figures were at the $440 million dollar

level and it declined 50% to $210 million by 1978. However, by 1980, figures had

revived to $738million, with majority of FDI flowing into the oil sector of the

economy in response to bullish oil prices. FDI steadily began to drop, first

dropping 54% to $542 million by 1981, before declining to an all time low of

$189million by 1984. Nigeria broke the billion dollar benchmark for FDI in 1989

were net FDI inflows were set at $1.88billion. The level of correlation between

the level of world oil prices and FDI inflows to Nigeria is particularly strong,

especially in the 2000s, were the rise in oil prices undoubtedly explains the most

of the sharp rises in FDI.

By 1994, FDI had risen to $1.9billion, and after dropping to $1billion in 1995, the

path of FDI was uneven, but within the bounds of the billion dollar mark until

2003, where it finally hit the $2billion dollar mark, steadily rising to $4billion

80

dollars in 2005, and finally doubling to $8.8billion dollars in 2006, which was a

landmark year for FDI in Nigeria. Following the decline of world commodity

prices and in response to the effects of the global financial crises, coming to rest

at $3billion dollars in 2008.

4.3 ANALYSIS OF MODEL AND INTERPRETATION.

Summary of Model to be tested.

Independent Variables

Expressed As Testing Expected Sign

Nominal GDP NGDP Market Growth +

Exchange Rate fluctuations

EXR Macroeconomic Instability

-

Trade Openness TOPN Level of trade restriction

+

Electricity Consumption

ELCON Infrastructure availability

+

Results

VARIABLE COEFFICIENT STD.ERROR T-STATISTIC PROBABILITY

c 14.04975 5.578054 2.518754 0.0180

Ln(NGDP) 0.168079 0.233676 0.719285 0.4781

TOPN 0.022582 0.007160 3.153793 0.0039

EXR 0.004256 0.003092 1.376482 0.1800

ELCON 0.012933 0.004704 2.749107 0.0105

R2 = 0.759686 Adjusted R2 = 0.724084 Durbin-Watson

(DW) = 1.540862

81

F-statistic = 21.33826 Prob(F-statistic) = 0.000000

Akaike info criterion = 1.630010 Schwarz criterion = 1.859031

Apriori Expectations. As expected, Nominal GDP, Trade openness and electricity consumption possess

a positive relationship with FDI in Nigeria. However, Exchange rates exhibits a

positive relationship with FDI as opposed to a negative sign as expected.

Since,

LnFDIit = β

0 + β

1 LnNGDP

it + β

2 TOPN

it + β

3EXR

it +β

4ELCON

it + ε

it

Therefore,

LogFDI = 14.04974563 + 0.1680793957*LOG(NGDP) + 0.02258210082*TOPN

+0.004256418531*EXR + 0.01293277465*ELCON + ε it

This implies that

A 1% increase in Nominal GDP increases FDI by approximately 0.168%.

A 1 unit increase in trade openness increases FDI by approximately 2.25%

A 1 unit appreciation in exchange rate increases FDI by approximately 0.42%

A 1 unit increase in Electricity consumption increases FDI by 1.2%

If the other explanatory variables are set at zero, then FDI increases by 14.04%

4.4 ESTIMATION METHODS

Coefficient of determination (R2):

82

The regression results show that the explanatory variables explained

approximately 76 percent variations in foreign direct investment in Nigeria, while

the adjusted values indicate that 72 percent of variations in FDI in Nigeria.

Durbin Watson test

The observed value of the DurbinWatson (DW) = 1.540862. This implies

that there is relatively weaker positive auto-correlation of the error term

detected, (as d →2 auto-correlation diminishes until it becomes zero at d =

2).

The F- statistic.

Fcalc = 21.336 Fcritical = 2.90

Since Fcalc > Fcritical at 5% level of significance we reject null hypothesis that there

is no linear relationship between explanatory variables; i.e. H0 : β1 = β2 = β3 = β4

= 0 is rejected.

The t- statistic.

For LnNGDP,

83

H0: β1 = 0 H1: β1 ≠ 0.

Since 0.4781 > 0.05, we DO NOT reject the null hypothesis at 95% confidence

level, therefore market size is NOT statistically significant.

For TOPN

H0: β2 = 0 H1: β2 ≠ 0

Since 0.0039 < 0.05, we reject the null hypothesis at 95% confidence level, and

therefore trade-openness is statistically significant.

For EXR,

H0: β3 = 0 H1: β3 ≠ 0

Since 0.1800 > 0.05, we DO NOT reject the null hypothesis at 95% confidence

level, and therefore exchange rate is NOT statistically significant determinant.

For ELCON

H0: β4 = 0 H1: β4 ≠ 0

Since 0.01015 < 0.05 we reject the null hypothesis at 95% confidence level. This

implies that infrastructure development is statistically significant.

84

Variable Parameter p-value Decision @ 5%

Significance Level

LnNGDP β1 0.4781 Do Not Reject null

hypothesis

TOPN β2 0.0039 Reject null

hypothesis

EXR β3 0.1800 Do Not Reject null

hypothesis

ELCON β4 0.01015 Reject Null

hypothesis

Augumented Dickey-Fuller results.

Before estimation, we performed a stationarity (unit root) test that includes the

intercept and trend. This is to test for stationarity of the data in order to confirm

that the data used is not spurious. The result of the unit root test is presented

below:

85

FDI- dependent variable

VARIABLE 99% CRITICAL VALUE* FOR THE ADF-STATISTIC

ADF- TEST STATISTICS

ORDER OF INTEGRATION

ADF LAG LENGTH

FDI -4.3082 -4.312084 I(1) 1

NGDP -4.3226 -5.281010 I(2) 1

TOPN -4.3226 -6.271700 I(2) 1

EXR -4.3226 -5.860478 I(2) 1

ELCON -4.3226 -7.499003 I(2) 1

*MacKinnon critical values for rejection of hypothesis of a unit root.

The results show that FDI is stationary on first differencing while; nominal GDP,

trade openness, exchange rate and electricity consumption are stationary on the

second differencing. Therefore, the data set used is not spurious.

86

CHAPTER FIVE

RECOMMENDATIONS AND CONCLUSION

5.1 SUMMARY OF FINDINGS

The market size was found to be insignificant in attracting FDI into Nigeria, at

5% significance level, though the coefficient of market size shows a positive

relationship between FDI and market size. This is consistent with the findings of

Dinda(2009). Furthermore, the results also reveal that exchange rate is also

insignificant in explaining changes in FDI in Nigeria, which is surprising given

past works that confirm its statistical significance. However trade-openness is

found to be statistically significant at the 5% level in attracting FDI into Nigeria.

A 1 unit increase in trade-openness increases FDI by approximately 2.25%.

Finally, infrastructure development (proxied by electricity consumption) is shown

to have a statistically significant relationship with FDI in Nigeria. A 1 unit

increase in electricity consumption is expected to increase FDI by approximately

1.2%. The significance of trade-openness and infrastructure development was

corroborated by the findings of Asiedu(2004). The overall model is found to be

statistically significant with recourse to calculations of the F statistic, which helps

to test this.

5.2 POLICY RECOMENDATIONS Planning Public Investment in Infrastructure.

87

One factor that could position Nigeria as a favourable investment destination

among developing countries competing for similar investments is the creation of

an efficient infrastructure base. This is considered one of the strong attractions to

investment in Singapore for instance. To maximize impact, public infrastructure

investments need to be better planned and prepared and execution should promote greater

efficiency in the context of broader public expenditure management and budget reforms.

However there are still some gaps. Infrastructure planning and budgeting need to be

strengthened in several ways: (i) Infrastructure planning should link more closely with

clearly defined and realistic targets for infrastructure development; (ii) Infrastructure

planning should prioritize and fully cost alternative investments; and (iii) Infrastructure

planning should establish a clear monitoring mechanism to measure progress in execution

and justify continued funding until completion.

Furthermore, the existing public infrastructure investment projects needs to be critically

reviewed. Several have been under execution for several years. Such a review could form

the basis for weeding out projects that can no longer be justified and ensuring that

resources are focused on sounder set of projects. Projects need to be much better prepared

using technical and financial analysis and transparent and meaningful criteria need to be

adopted to form the basis of prioritization and selection between different public

expenditure and investment options. Also considerable capacity building will be needed

for relevant ministries in charge of infrastructure development. Personnel should be

trained and brought up to date on preparation of medium term plans, project appraisal

techniques as well as on project monitoring systems.

It is important to strengthen coordination between the different tiers of government for

infrastructure investment planning, implementation and monitoring. An integrated

framework for infrastructure investment planning between federal, state and local

88

governments needs to be put in place. Greater collaborations between the different tiers

of government will minimize wasteful spending and create greater value for money.

Private participation in infrastructure reduce pressures on government spending and

improve the efficiency of infrastructure service delivery. Key benefits of Public-Private

Partnerships (PPPs) in infrastructure include: (i) efficiency gains from access to

innovative technologies and economies of scope, (ii) cost reduction through allocation of

projects to the best bidder at lowest costs. (iii) Enhanced public management capacity as

government focuses on infrastructure facilitation and monitoring, leaving service

provision to the private sector. The Infrastructure Concession Regulatory Act (PPP Act)

adopted in November 2005, provides the legal basis for pursuing PPPs in all

infrastructure sectors in Nigeria. It foresees build-operate-transfer (BOT) concessions for

green-field infrastructure projects, while contracts for existing infrastructure will be

awarded on a repair-maintain-operate-transfer (RMOT) basis. The Act also established

the Infrastructure Concession Regulatory Commission to regulate, monitor and supervise

infrastructure contracts.

Revise Trade Policy.

Low level of intra-African trade is attributable in large part to the poor

infrastructure facilities between African countries, further highlighting the need

for a efficient and reliable infrastructure. In West Africa, for instance, charges for

phone calls to neighboring countries are exorbitant. Nigeria should take advantage

of AGOA (Africa Growth and Opportunities Act) initiative, which promotes

exports to the United States. Member States of ECOWAS should also pursue an

investment framework agreement at the sub-regional level, which could provide

greater protection, transparency, stability and predictability, and encourage further

liberalization. Nigeria should renew its commitment to enforce the ECOWAS

89

trade liberalization scheme and accelerate regional infrastructure development

(UNCTAD, 2002). This should prove to be beneficial in promoting a well-

integrated West African market, thus enabling potential investors to gain access to

the whole region through investments in one of its member countries. Also the

government should review the existing tariff structure, including import

protection policies. Import protection should be minimized in order to expose

local industries to external competition precipitating efficiency and best practices

in its business methods. Also, the government should set specific priorities with

timescale in the short, medium and long-term with respect to free trade area,

customs union and common market. Exchange rate policy reforms should target

the increase in the overall availability of foreign exchange and to improve foreign

exchange allocation mechanisms. The exchange rate regime should be followed

through by a tight fiscal and monetary policy stance. Increased liberalization of

the exchange rate regime within a stable macroeconomic environment offers

investor’s incentives to set-up export oriented units of production in Nigeria. All

the more so since Nigeria’s liberalized regime enables its exports to be more

competitive on world markets, barring other domestic capacity and external

market access constraints.

5.3 LIMITATIONS OF THE STUDY

Reliability of FDI statistics in Nigeria is suspect primarily due to a lack of

systemic data collection on MNC activities in Nigeria, such as employment and

tax payments.

90

5.4 CONCLUSION

The low level (and fluctuation) of FDI to Nigeria, the significance of FDI in a

developing economy, and the recent surge in FDI inflows to Nigeria motivated

this study. The ordinary least squares regression technique was employed to

estimate the relationship between FDI and its potential determinants. The

regression results showed that the principal determinants of FDI are infrastructure

development and the degree of trade openness.

91

APPENDIX

DATA PRESENTATION

YEAR FDI($) NGDP($) TOPN(%) EXR(N toUSD)

ELCON(kwhpercapita)

1977 440514242.5 36035407725 43.12356812 0.644701062 58.5263443

1978 210933271.4 36527862209 41.53721781 0.635271994 59.9391381

1979 309598869.2 47259911894 40.9279642 0.604007374 59.0073096

1980 738870004.4 64201788077 46.6789482 0.546780892 67.0531839

1981 542327289.1 59918536009 48.29332215 0.617708175 50.1021464

1982 430611256.5 49763409962 37.74850235 0.673461262 80.544251

1983 364434580.2 34950458716 27.03717697 0.724409851 80.327255

1984 189164784.9 28182543199 23.60887879 0.766527449 60.9508176

1985 485581320.9 28407930899 25.90006366 0.893774083 78.9541932

1986 193214907.5 20210788382 23.71675632 1.754523004 89.1250821

1987 610552091.5 23441334769 41.64665855 4.016037344 87.5091695

1988 378667097.7 22847726915 35.31198088 4.536966667 85.3304129

1989 1884249739 23843508697 60.39176112 7.364735 94.9981597

1990 587882970.6 28472471051 53.03022274 8.038285 85.1771806

1991 712373362.5 27313352202 64.87659873 9.909491667 87.6091832

1992 896641282.5 32710369046 61.03097314 17.298425 88.0296604

1993 1345368587 21352759382 58.10984891 22.0654 98.6012122

1994 1959219858 23663389441 42.30887041 21.996 93.392579

1995 1079271551 28108826038 59.76783404 21.89525833 89.416567

1996 1593459222 35299150000 57.690994 21.884425 83.9751451

1997 1539445718 36229368992 76.8599907 21.88605 80.1883882

92

1998 1051326217 32143818182 66.17324479 21.886 75.2990902

1999 1004916719 34776040200 55.84639122 92.3381 74.16518

2000 1140137660 45983600313 71.38053102 101.6973333 72.96401

2001 1190632024 47999775243 81.81284909 111.23125 74.0787293

2002 1874042130 59116847821 63.38363718 120.5781583 101.8840181

2003 2005390033 67656023324 75.21890251 129.22235 99.7170312

2004 1874033035 87845420492 50.73691174 132.888025 120.8198718

2005 4982546589 1.12E+11 54.34669564 131.2743333 127.0242831

2006 8823502346 1.47E+11 64.0865445 128.6516667 109.9719281

2007 6032054729 1.66E+11 65.4424281 125.8081083 137.1902732

2008 3635553931 2.07E+11 76.112 118.92 184.2978

PRESENTATION OF OLS RESULTS

Dependent Variable: LOG(FDI) Method: Least Squares Date: 09/21/10 Time: 21:17 Sample: 1977 2008 Included observations: 32

Variable Coefficient Std. Error t-Statistic Prob.

C 14.04975 5.578054 2.518754 0.0180 LOG(NGDP) 0.168079 0.233676 0.719285 0.4781

TOPN 0.022582 0.007160 3.153793 0.0039 EXR 0.004256 0.003092 1.376482 0.1800

ELCON 0.012933 0.004704 2.749107 0.0105

R-squared 0.759686 Mean dependent var 20.69107 Adjusted R-squared 0.724084 S.D. dependent var 0.969084 S.E. of regression 0.509037 Akaike info criterion 1.630010 Sum squared resid 6.996212 Schwarz criterion 1.859031 Log likelihood -21.08016 F-statistic 21.33826 Durbin-Watson stat 1.540862 Prob(F-statistic) 0.000000

93

Estimation Command: ===================== LS LOG(FDI) C LOG(NGDP) TOPN EXR ELCON Estimation Equation: ===================== LOG(FDI) = C(1) + C(2)*LOG(NGDP) + C(3)*TOPN + C(4)*EXR + C(5)*ELCON Substituted Coefficients: ===================== LOG(FDI) = 14.04974563 + 0.1680793957*LOG(NGDP) + 0.02258210082*TOPN + 0.004256418531*EXR + 0.01293277465*ELCON

PAIRWISE CORRELATION MATRIX

LOG(FDI) LOG(NGDP) TOPN EXR ELCON LOG(FDI) 1.000000 0.655201 0.697364 0.764822 0.711000

LOG(NGDP) 0.655201 1.000000 0.417981 0.745765 0.620339 TOPN 0.697364 0.417981 1.000000 0.607532 0.386274 EXR 0.764822 0.745765 0.607532 1.000000 0.637894

ELCON 0.711000 0.620339 0.386274 0.637894 1.000000

White Heteroskedasticity Test:

F-statistic 1.843998 Probability 0.119825 Obs*R-squared 12.50434 Probability 0.130080

Test Equation: Dependent Variable: RESID^2 Method: Least Squares Date: 09/22/10 Time: 16:47 Sample: 1977 2008 Included observations: 32

Variable Coefficient Std. Error t-Statistic Prob.

C 341.9207 151.2160 2.261141 0.0335 LOG(NGDP) -27.82524 12.24598 -2.272194 0.0327

(LOG(NGDP))^2 0.566712 0.248062 2.284563 0.0319 EXR 0.006244 0.010346 0.603528 0.5521

EXR^2 -4.28E-05 8.38E-05 -0.510184 0.6148 TOPN -0.005244 0.023422 -0.223894 0.8248

TOPN^2 3.90E-05 0.000217 0.179439 0.8592 ELCON -0.002219 0.014031 -0.158185 0.8757

ELCON^2 -9.14E-06 6.46E-05 -0.141419 0.8888

R-squared 0.390760 Mean dependent var 0.218632 Adjusted R-squared 0.178851 S.D. dependent var 0.334314 S.E. of regression 0.302946 Akaike info criterion 0.681734 Sum squared resid 2.110855 Schwarz criterion 1.093972 Log likelihood -1.907746 F-statistic 1.843998 Durbin-Watson stat 2.764795 Prob(F-statistic) 0.119825

94

ADF TEST RESULTS

ADF Test Statistic -4.312084 1% Critical Value* -4.3082 5% Critical Value -3.5731 10% Critical Value -3.2203

*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(LOG(FDI),2) Method: Least Squares Date: 09/22/10 Time: 14:34 Sample(adjusted): 1980 2008 Included observations: 29 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob.

D(LOG(FDI(-1))) -1.597069 0.370371 -4.312084 0.0002 D(LOG(FDI(-1)),2) 0.057994 0.209051 0.277417 0.7837

C 0.114700 0.245640 0.466945 0.6446 @TREND(1977) 0.002269 0.013240 0.171347 0.8653

R-squared 0.747399 Mean dependent var -0.030692 Adjusted R-squared 0.717086 S.D. dependent var 1.095218 S.E. of regression 0.582542 Akaike info criterion 1.884612 Sum squared resid 8.483885 Schwarz criterion 2.073204 Log likelihood -23.32687 F-statistic 24.65671 Durbin-Watson stat 1.823969 Prob(F-statistic) 0.000000

95

ADF Test Statistic -5.281010 1% Critical Value* -4.3226 5% Critical Value -3.5796 10% Critical Value -3.2239

*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(LOG(NGDP),3) Method: Least Squares Date: 09/22/10 Time: 14:38 Sample(adjusted): 1981 2008 Included observations: 28 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob.

D(LOG(NGDP(-1)),2) -1.790235 0.338995 -5.281010 0.0000 D(LOG(NGDP(-1)),3) 0.172448 0.194394 0.887105 0.3838

C -0.091618 0.099962 -0.916525 0.3685 @TREND(1977) 0.004980 0.005196 0.958497 0.3474

R-squared 0.773224 Mean dependent var 0.001800 Adjusted R-squared 0.744877 S.D. dependent var 0.436452 S.E. of regression 0.220451 Akaike info criterion -0.054719 Sum squared resid 1.166368 Schwarz criterion 0.135596 Log likelihood 4.766063 F-statistic 27.27703 Durbin-Watson stat 1.933503 Prob(F-statistic) 0.000000

ADF Test Statistic

-6.271700 1% Critical Value* -4.3226

5% Critical Value -3.5796 10% Critical Value -3.2239

*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(TOPN,3) Method: Least Squares Date: 09/22/10 Time: 14:39 Sample(adjusted): 1981 2008 Included observations: 28 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob.

D(TOPN(-1),2) -2.245828 0.358089 -6.271700 0.0000 D(TOPN(-1),3) 0.309055 0.193817 1.594573 0.1239

C -1.747765 6.586777 -0.265345 0.7930 @TREND(1977) 0.120811 0.341842 0.353411 0.7269

R-squared 0.871822 Mean dependent var 0.105480 Adjusted R-squared 0.855800 S.D. dependent var 38.46350 S.E. of regression 14.60599 Akaike info criterion 8.332304 Sum squared resid 5120.038 Schwarz criterion 8.522619 Log likelihood -112.6523 F-statistic 54.41344 Durbin-Watson stat 2.132921 Prob(F-statistic) 0.000000

96

ADF Test Statistic

-5.860478 1% Critical Value* -4.3226

5% Critical Value -3.5796 10% Critical Value -3.2239

*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(EXR,3) Method: Least Squares Date: 09/22/10 Time: 14:41 Sample(adjusted): 1981 2008 Included observations: 28 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob.

D(EXR(-1),2) -1.958382 0.334168 -5.860478 0.0000 D(EXR(-1),3) 0.315536 0.193689 1.629084 0.1164

C 3.289616 7.172697 0.458630 0.6506 @TREND(1977) -0.207291 0.372477 -0.556520 0.5830

R-squared 0.769751 Mean dependent var -0.143521 Adjusted R-squared 0.740970 S.D. dependent var 31.17718 S.E. of regression 15.86763 Akaike info criterion 8.498003 Sum squared resid 6042.758 Schwarz criterion 8.688318 Log likelihood -114.9720 F-statistic 26.74500 Durbin-Watson stat 2.138425 Prob(F-statistic) 0.000000

ADF Test Statistic -7.499003 1% Critical Value* -4.3226 5% Critical Value -3.5796 10% Critical Value -3.2239

*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(ELCON,3) Method: Least Squares Date: 09/22/10 Time: 14:43 Sample(adjusted): 1981 2008 Included observations: 28 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob.

D(ELCON(-1),2) -2.545896 0.339498 -7.499003 0.0000 D(ELCON(-1),3) 0.691501 0.198862 3.477296 0.0019

C -5.306381 7.162850 -0.740820 0.4660 @TREND(1977) 0.405965 0.372215 1.090675 0.2862

R-squared 0.826594 Mean dependent var 0.389696 Adjusted R-squared 0.804918 S.D. dependent var 35.92328 S.E. of regression 15.86664 Akaike info criterion 8.497878 Sum squared resid 6042.004 Schwarz criterion 8.688193 Log likelihood -114.9703 F-statistic 38.13438

97

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