How does capital flows affect the impact of trade on economic growth in Africa?

ABSTRACT

The paper empirically examines the extent to which different forms of capital flows (foreign direct investment [FDI], remittances, foreign aid and external debt) affect the impact of trade (exports) on economic growth in Africa. We do this with the aid of an augmented endogenous growth model which we estimate by dynamic system GMM technique with endogeneity-expunging efficiency. First, we find that whilst the direct impact of trade (exports) has been crucial in driving economic growth in Africa in both the short- and long-run, capital flows (FDI, remittances, foreign aid and external debt) do not. Second, our results clearly show that, in both the short- and long-run, inflows of FDI and remittances serve as important channels through which trade (exports) has its largest impact on economic growth while inflows of foreign aid and external debt do not. Following these outcomes, we conclude that policies aimed at attracting FDI and remittances to African countries are what policy reforms should target. Further, our findings suggest that moderating the inflow of external debt and foreign aid could be beneficial to the effect of trade (exports) on economic growth.

KEYWORDS:

• Capital flows
• exports
• economic growth
• Africa

JEL CLASSIFICATIONS:

• C23
• F10
• F20
• F30
• O47
• O55

Acknowledgements

An earlier version of the paper was presented at African Review of Economics and Finance Conference held at Ghana Institute of Management and Public Administration (GIMPA), Accra, Ghana on 30–31 August 2017. The authors thank participants of this conference and anonymous reviewers and the editor of this journal for the helpful comments and suggestions. All remaining errors are those of the authors.

Disclosure statement

No potential conflict of interest was reported by the authors.

ORCID

John Egyir http://orcid.org/0000-0001-9965-6031

Daniel Sakyi http://orcid.org/0000-0002-4231-0061

Samuel Tawiah Baidoo http://orcid.org/0000-0001-5941-6308

Notes

1 Capital flows may take several forms including FDI, remittances, foreign aid, external debt, among others.

2 For the case of Africa, Busse, Erdogan, and Mühlen (2016) note that the presence of economic activities of China in Africa in the last two decades have led to a significant increase in trade, FDI and foreign aid inflows.

3 For a comprehensive review of the role of capital flows in African economies readers are referred to (Adams 2009; Barajas et al. 2010; Lartey 2013; Nwaogu and Ryan 2015; Klobodu and Adams 2016; Adams, Klobodu, and Lamptey 2017).

4 The list of countries considered in the study is presented in the Appendix. The period considered put our study into perspective as it captures the time where majority of these countries had gone through trade and capital account liberalisation programmes and have experienced increased inflows of foreign capital.

5 We also control for imports to also examine whether or not economic growth in Africa is imports-led.

Additional information

Funding

Authors acknowledge financial support from Volkswagen Foundation (VW) Foundation within its Postdoctoral Fellowship-Program in the Social Sciences in Sub-Saharan Africa [grant number 89867].