Does FDI improve economic development in North African countries?

Abstract

This article examines the relationship between FDI inflows and welfare improvement in North African countries. Using net per capita FDI inflows and the United Nations Development Program’s Human Development Index as the principal variables, our analyses confirm the positive and strongly significant relationship between net FDI inflows and welfare improvement in North Africa, although we do find significant differences among the countries in the region. This relationship holds even after we control for government size, country indebtedness, macroeconomic instability, infrastructural development, institutional quality, political risk, openness to trade, education and financial market development. Hence, at the aggregate level, FDI contributes to economic growth in North Africa, in turn generating additional revenues for governments and populations in the region through fiscal policies and jobs creation. We also found that FDI received by countries in the region are mainly concentrated in very few industries (particularly extractive petroleum, services and tourism, construction and utilities); relatively fewer of these investments are directed towards the nonextractive primary industries, which are pro-poor sectors and highly labour intensive, or the manufacturing sector, with a high potential for spillover effects in the economy. This lack of diversification of FDI received in the region’s economies in part explains the differences observed in the link between FDI and welfare in these countries. It is therefore essential for governments in the region to continue investing in social infrastructures while improving the quality of their institutions and their governance; doing so will probably help avoid the type of unrest we have witnessed recently.

Keywords:

• FDI
• economic growth
• North Africa
• welfare

JEL Classification:

• F21
• F36

Acknowledgements

This article was prepared as part of the African Development Bank North Africa Paper Series 2013. I am grateful for the comments and suggestions of Dr Gaston Gohou, President of CESS Institute (Canada), and of the participants at the North Africa Policy Series presentation held at the African Development Bank Headquarters in Tunis (Tunisia), especially, Vincent Castel, Mohamed H’Midouche and Sahar Rad. I thank the editor and two anonymous referees for their very constructive comments and suggestions, which have greatly enhanced the quality of the article. The views expressed in this article do not in any way reflect those of the African Development Bank. I thank Yao Djifa N’Sougan for valuable research assistance. All errors are the author’s sole responsibility.

Notes

¹ For details, visit the MDG website at www.un.org/millenniumgoals/

² See, for example, the 7 February 2009 issue of The Economist on ‘The return of economic nationalism’ (www.economist.com).

³ As computed by the UNDP.

⁴ The HDI is more closely related to welfare, a broader concept than typical measures of poverty. However, to link our article to the MDGs and for ease of understanding, we will use ‘poverty reduction’ for ‘welfare’ throughout the article when necessary.

⁵ Poverty incidence is an indicator of poverty from household surveys. An estimate of the international poverty incidence is performed by the World Bank (see PovNet). The accuracy of the data underlying this international poverty incidence has been challenged recently. For instance, the World Bank has reviewed the bases of the 2009 estimate; following that review, the indicator data has changed drastically. Moreover, data are not available for every year. Here, the poverty incidence refers to the one calculated using household surveys. This poverty incidence is more accurate but also has several drawbacks, such as availability, comparability across countries, etc.

⁶ This differs from the initial studies on economic growth that had recognized that technological progress is the main driver of sustainable growth (Solow, 1956).

⁷ See Sumner (2005) for a detailed discussion of various channels.

⁸ This requires repatriation of profits and royalties to be less than FDI inflows. Moreover, the taxes paid in relation to FDI must be higher than subsidies and fiscal relief (Sumner, 2005).

⁹ In their study, ‘quality’ refers to the effect of a unit of FDI on economic growth.

¹⁰ Sharma and Gani’s measure of FDI is net FDI inflows as a percentage of GDP.

¹¹ To avoid redundancy, we drop this last variable later as it yields the same results as FDI/GDP.

¹² For details on how to calculate the HDI, refer to the technical note of the Human Development Report available in UNDP (2010).

¹³ Because HDI includes education, in order to avoid spurious regressions, we do not include education in the regressions which consider the HDI as a dependent variable.

¹⁴ This is slightly different from the findings in Gohou and Soumaré (2012) for North Africa, where they found the relationship between FDI and the HDI to be nonsignificant. This may be explained, first by the fact that they do not consider the nonlinearity of the relationship. Indeed, in column 1 of Table 5 where we do not take the log of REALFDIPOP, the coefficient is not significant, as in Gohou and Soumaré (2012). But when we introduce the nonlinearity by taking the log, the coefficient becomes significant. Also, note that here we are using per capita FDI in real terms, whereas Gohou and Soumaré (2012) use current FDI prices divided by population size. Finally, we perform our estimations using the dynamic panel Arellano–Bond estimation technique rather than the Robust Newey–West estimation technique.

¹⁵ This may be because much data is missing for Libya.

¹⁶ The results with this FDI indicator are available from the author upon request.

¹⁷ We are grateful to an anonymous referee for bringing this last explanation on the absorptive capacity of countries to our attention.

¹⁸ The small sample size (six countries and 21 years) can have some impact on our results. Nonetheless, the article’s findings constitute a good basis to formulate policy recommendations for the region’s countries’ decision-makers and for foreign investors.

¹⁹ It has to be noted that the lack of detailed and micro-level data on FDI sectorial distribution limits our ability to formulate some specific recommendations supported by the analyses. In addition, in future researches, it would be interesting to explore the impact of FDI on the environment (hence, the welfare of the local communities), especially for foreign investments in environmentally sensitive sectors.

Additional information

Funding

I wish to acknowledge the financial support received from the Regional Department North of the African Development Bank.