Foreign Direct Investment, Political Business Cycles and Welfare in Africa

Abstract

This article examines the relationship among foreign direct investment (FDI), institutions and economic growth in sub-Saharan Africa in different country environs. We employ a two-step generalized methods of moments estimator with Weidmeijer corrected standard errors and orthogonal deviations to examine the empirical relations. In the full sample, we do not find evidence that FDI promotes growth. We also do not find a significant relationship between institutions and economic growth. Finally, we do not find convincing evidence that institutions alter favorably the effect of FDI on economic growth. In the subsample that excludes countries with developed financial markets, again we do not find a significant relation between FDI and economic growth. However, we find evidence suggesting that institutions play a direct role in spurring economic growth. Further, the quality of institutions seems to alter favorably the relationship between FDI and economic growth. Finally, in the sample that excludes countries with abundant natural resources, we find a direct and positive relationship between FDI and economic growth. We also find a direct relationship between institutions and economic growth. The growth-enhancing effects of FDI, however, seem to reduce as the quality of institutions improves. The major implication from our study is that countries should take into consideration their own realities when they fashion policies to benefit from FDI in terms of achieving better growth outcomes.