Financial globalization and institutions in Africa: the case of foreign direct investment, central bank independence and political institutions

Abstract

In this paper, we examine the bi-directional relationship between financial globalization (proxied by foreign direct investment (FDI) flows) and economic institutions (proxied by central bank independence (CBI)) taking into consideration the role of political institutions. We test our argument on a sample of 48 African countries (1970–2012) using a two-step System Generalized Methods of Moments, with collapsed instruments and Windmeijer robust standard errors. Using two proxies for CBI, the study finds that while legal CBI does not have a significant impact on FDI, high central bank governor turnover rates have a significantly negative impact on FDI inflows. However, higher levels of political institutions significantly enhance the impact of legal CBI on FDI inflows, and dampen the impact of high central bank governor turnover rates on FDI inflows. The study also shows that higher FDI inflows have a significantly positive impact on both legal and de facto CBI. This impact is accelerated in countries characterized by higher levels of political institutions.