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Foreign direct Investment in Southern Africa
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EXECUTIVE SUMMARY
Introduction
This paper presents the findings of a study analysing the major factors determining the form and
volume of private foreign direct investment in Southern Africa. This study aims to ascertain (i)
what are the primary motivations for investment in Southern Africa and (ii) whether the form of
new foreign investment influences its developmental effects. By assessing the motivations for
direct investment in the region and the extent to which FDI contributes to new employment and
to skills transfer, it seeks to shed light on appropriate policies to pursue in order to encourage
higher volumes of FDI and their likely implications for economic development. FDI is one element
linking Southern Africa to the global economy. The volume and forms that can be attracted will
influence whether Southern Africa’s poor can benefit from globalisation of markets.
Lessons from theory and experience
Determinants of private (domestic and foreign) investment
The economic literature on private capital formation in developing countries is largely concerned
with the issue of uncertainty and risk as disincentives to investment. Macroeconomic instability
is found to be a disincentive as is the presence of large external debt burdens. The variability of
both the exchange rate and the rate of inflation - more than their levels - causes investors to
hesitate to commit significant resources. Uncertainty about the future will dominate decisionmaking,
even when potentially profitable opportunities exist. For this reason, lags in the
investment response to macroeconomic adjustment can be very long. Political uncertainty
exacerbates perceptions of a fragile investment climate.
Determinants of foreign direct investment
Multinational enterprises may base FDI decisions on one or more of the following factors: a
secure and cheaper source of regularly required inputs; the desire to defend or expand markets
or service existing clients in a particular foreign region; the wish to rationalise production into a
network of the most efficient production bases supplying the largest possible worldwide market;
and other strategic considerations with respect to the firm’s international position. These can be
summarised as providing two distinct motives for FDI: market access and production costs. The
former derives from the gain of being close to consumers, and tends to be associated with
distribution outlets and/or production purely for the local market. The second arises from the
benefits of being able to base production in low-cost locations, and tends to be correlated with
export orientation.
Foreign direct investment in Africa
Although these determinants apply generally to multinational investment, there are features
particularly important to Africa which should be taken into account. The indicators which have
been found most frequently to be correlated with increased FDI in Africa in cross-country
empirical analyses are: economic openness, especially to international trade; the quality of
institutions and physical infrastructure in the host economy; and economic growth and stability.
Investor surveys in Africa have tended to emphasise economic instability and institutional
weaknesses as the main barriers to increased levels of FDI.
The developmental effects of FDI
The developmental benefits of FDI are not automatic, and mechanisms may be required to ensure
that the expected benefits of FDI are equitably distributed in order to make a positive impact on
poverty alleviation and social welfare. Possible developmental benefits include employment
creation, the promotion of forward and backward linkages in the host economy, the development
of human capital, the implementation of internationally acceptable codes of employment practice,
improving the access of the host economy to world markets, and augmenting corporate tax
revenues.
FDI in Southern Africa: an overview
The experience of SADC members in attracting long-term capital flows has been mixed. In US
dollar terms, the amount of FDI received by SADC is a small fraction of total flows to low and
middle income economies: between 1995 and 1999, the approximate share of SADC in total FDI
to developing countries varied between 2 and 3 percent. However, for some countries in the
region, annual inflows expressed as a percentage of GDP have, at times, significantly exceeded
flows to other developing economies: for instance Angola in 1998-9; Lesotho and Seychelles in
1995-99; and Mozambique in 1999. This is often explained by a limited number of large
transactions in relatively small economies, including investment in natural resource exploitation
and infrastructure development, and also privatisation transactions. Privatisation has been an
important source of FDI for some SADC countries - such as Mozambique, Tanzania and Zambia -
but, in general, slow progress in the sales of the largest parastatal entities suggests that there is
considerable scope for further inflows of foreign investment over time.
South Africa dominates foreign investment in SADC, receiving a substantial fraction of new FDI
inflows into the region and hosting the greatest number of foreign subsidiaries across a broad
range of economic sectors. South Africa’s capacity to act as a magnet for FDI in the region,
particularly in the context of growing regional economic integration, is an important feature of
investment flows.
Determinants and characteristics of FDI in Southern Africa
The analysis in this study draws on a survey conducted with (predominately) European parent
companies with operations in SADC. This survey aimed to explore the following issues:
motivations for investment; the market orientation of subsidiaries in Southern Africa; decisions
on expansion versus contraction and implications for employment; the ownership structure of
investments; the method of entry into the host economy; the impact of economic policy on
operations in SADC; and perceptions of risks.
Motivations for investment
The most important motivation for investment in Southern Africa is the size of the local market.
Most of the non-primary sector enterprises in the sample have a local market focus, and few are
seeking to develop export capacity to markets outside the region in the medium term (the
exceptions are all located in South Africa). The creation of a functioning free trade area is likely
to provide the economies of scale needed for profitable production, and thus should encourage
more direct investment in the region. South Africa - the largest domestic market in Southern
Africa - is seen by many investors to be pivotal for regional production and trade.
Other important motivations for investment include the presence of natural resources; historical
links with Africa; privatisation programmes or public-private partnership schemes; and - for
several service sector firms - strategic factors associated with servicing global corporate clients.
Firms with long-standing historical links are more likely to remain in times of uncertainty, even
when new firms might be deterred from entry, and may be significant sources of additional
investment over time.
As a motivation for location in Southern Africa, market seeking is more important than cost
considerations. South Africa is more attractive than its neighbours for secondary- and tertiarysector
enterprises, and it acts as a base for production for the region and, in some cases, for
exporting to the rest of the world. The main location-specific reasons for this pattern is superior
infrastructure, physical and financial, and the fact that South Africa is by far the largest economy.
Enterprise growth and employment
Half of the firms interviewed in this survey increased the scale of (existing) operations in the past
five years, and just over half are planning expansion in the next five. However, enterprise growth
is not always accompanied by employment growth. In manufacturing, rising capital intensity and
improved productivity may limit the benefits of FDI in terms of ongoing job creation. On the other
hand, skills transfer and joint ownership of assets with local partners is taking place in the region,
although most firms in the sample tend to prefer to retain management control.
Mode of entry
There is some indication of an increase in the proportion of acquisitions in the last five years, in
line with world trends, but the shift is too small to indicate a significant change, and this may be
a temporary phenomenon as foreign firms take advantage of privatisation programmes, which
necessarily draw in foreign capital via acquisition. Greenfield investment continues to play an
important role. Acquisitions tended to occur in the primary sector; while greenfield investments
were more likely in the service sector.
Ownership structure
The choice of ownership structure tends to reflect the internal preferences of parent companies
with respect to control of their foreign subsidiaries. This is more influential than any factors
specific to the host economy or investment project. There is some weak evidence that full foreign
ownership occurs more frequently among secondary- and tertiary-sector firms producing for
export markets, indicating that control is viewed as important for quality and consistency of
supply.
Sources of risk
Foreign exchange and the quality of governance are the most common risk factors identified by
this sample of investors. Foreign exchange risks include instability of exchange rates, particularly
for those firms producing for local and regional markets, and availability of foreign exchange for
importing inputs and repatriating profits. Concerns about quality of governance cover a range of
issues, including the risk of intervention in property rights, corruption, and bureaucratic
uncertainty.
Other indicators of economic and political stability do not appear to have any consistent influence
on the characteristics of foreign investments in the sample. One reason for this is that economic
reform in several countries in the region may still be too fragile and too recent for it to have had
a marked effect on private investment behaviour.
Investors frequently argued that the “Africa perception” is a barrier to attracting new firms into
the region. Unfavourable perceptions of the credibility of reforms may well have their greatest
impact on those multinational corporations which are not yet committed to investment in Africa.
In other words, the view that instability is endemic across Africa, serves to undermine efforts to
attract potential FDI to the region.
Policy implications
Market orientation: local markets and regional integration
The primary reason for locating in Southern Africa is to take advantage of the local market. Most
of the non-primary sector enterprises have a local market focus, and - with the important
exception of several firms located in South Africa - these enterprises are not seeking to develop
global export capacity in the medium term.
Market size is influenced by the number of people to whom goods can be distributed and the
volume of their disposable income. Where domestic markets remain small, only a limited number
of foreign investors are likely to enter. Economic growth to increase the size of the local market
may therefore need to be a precursor to higher levels of FDI.
In the meantime, a functioning and sustainable free trade area is more likely to offer the
economies of scale required for investment to be profitable, and thus should encourage more
direct investment in the region. There is a risk that much of the FDI flowing into SADC will
locate in South Africa. Regional initiatives thus need to be designed carefully to ensure the
benefits of new FDI are broadly spread across the region. Where core economies attract most
foreign direct investment from outside the region, intra-regional resource flows may be
encouraged by the removal of exchange controls, particularly on FDI. This will enable private
capital in larger economies, especially South Africa, to seek profitable investment opportunities
in neighbouring countries.
Infrastructural development on a regional basis is a further mechanism for enhancing gains from
the FTA for the smaller economies and may also, in the longer term, help to encourage a more
even distribution of extra-regional FDI. The smaller economies in the region need to develop
financial, electronic and physical infrastructure in order both to stimulate domestic investment as
well as attract foreign capital.
Market orientation: creating export capacity
Existing markets, particularly local markets, remain the main focus of activities for most of the
enterprises in the sample. Where outward orientation of existing enterprises has either taken place
or is planned, these are all located in South Africa. For the smaller SADC economies, the
domestic market is too limited to generate significant endogenous development. For this reason,
it is crucial that production be aimed at a wider market, both regional and global.
Faster capital accumulation is vital, requiring a reduction in the risks to private investment in both
physical and human capital. Risks vary across countries but policy measures include conflict
resolution, greater political and macroeconomic stability, better legal systems and less corruption.
This policy agenda is common to all developing regions irrespective of factor endowments.
Where African economies face a particular challenge is in addressing the apparent perceptions of
potential international investors that political and economic instability is endemic.
Investment in education, training and research will be crucial in developing new industries, as will
investment in transport and communications. Expenditure on infrastructure and education is likely
to be of greater importance in the long term than tax and investment incentives for investors.
External factors which are crucial include the reform of the world trading system. It is widely
recognised that developing countries require greater negotiating capacity, especially in
international fora. Within regional frameworks such as SADC or wider efforts such as NEPAD,
cooperation in building a united position on trade negotiations will support a strengthening of
such capacity.
Perceptions of risk
The primary disincentives to locating in the region are perceptions of poor governance, volatile
exchange rates and/or a lack of access to foreign exchange.
Where volatile exchange rates are symptomatic of macroeconomic instability, the priority must
be economic stabilisation. The phasing out or scaling down of exchange controls on non-residents
in those countries where they remain, together with ensuring the availability of foreign exchange
is essential to attracting investment. Foreign exchange availability is particularly important in
terms of acquiring imported inputs and repatriating post-tax profits.
Predictable economic policies and political responses can be considered a prerequisite for FDI.
Countries need to be some way along the economic transition route to attract FDI, and lags in the
investment response to reforms may be very long, particularly where investors are concerned with
the credibility and sustainability of policies. Finally, government regulations and procurement
policies may deter some forms of FDI, particularly where they affect ownership. Governments
need to weigh the benefits of such micro-level interventions against the costs of erecting perceived
impediments to FDI.
Many of the motivations influencing the investment decisions of multinational companies apply
equally to domestic investors. Addressing the problems identified by foreign investors already
committed to the region should not only in the long run make Southern Africa more attractive to
new FDI but should in the shorter term encourage increased domestic investment.
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