Foreign direct investment is international investment made by a resident entity in one economy direct investors with the objective of establishing a lasting interest in an enterprise resident in an economy other than that of the investor (direct investment enterprise). Lasting interest implies the existence of a long term relationship between the direct investor and enterprise and a significant degree of influence by the direct investor on the management of the direct investment enterprises. Direct investment involves both the initial transaction between the two entities and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated.
FDI definition by world bank
Foreign direct investment is the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor.
3.3 Types of FDI
There are two types of Foreign direct investment: Horizontal and vertical FDI
3.3.1 Horizontal FDI : When multinational enterprises invest in different countries to produce the same goods and services we call it horizontal foreign direct investment.
3.3.2 Vertical FDI:- Multinational enterprises benefit from factor price difference and trade cost in the vertical foreign direct investment.
3.4 FDI policy framework
Arango (2008) divided FDI policies in to two: passive and active policies (Figure 3.2). The passive policies are related to comparative advantage of the countries like natural resource availability, low labour cost, countries' geographical location. It is showing the
world the comparative advantage of the country; letting FDI inflow in to host countries due to comparative advantage.
Active policies are related to the policies that are framed by government to attract more foreign direct investment. This includes macroeconomic stability, trade liberalization and infrastructure development. The active policy should align with the countries development
objectives as well as the MNC's strategy for mutual benefit.
Foreign direct
investment policies
Active Policies Passive Policies
Aligned with countries
Development objectives
Left mainly to the comparative
advantage of a nation
Figure3.2, Foreign direct investment policies source: Arango (2008) and author
3.5 FDI trends
During 1980's worldwide outflow of FDI increased by 29 percent growth rate of a year, it was three times faster than world export and four times faster than world output (UNCTAD1991). One of the reasons for increase in inflow of FDI in 1980's was the shift in sectors from raw materials to service and technology intensive manufacturing. In the
1950's mainly the FDI focused on raw materials however during 1980's and 1990's it
shifted to service and technology-intensive manufacturing. Moreover international
production through FDI is seen as complement and substitute for international trade and it eliminates trade barrier.
Based on World Investment Report (2010) half of global foreign direct investment inflow goes to developing and transitional economies (UNCTAD 2010). And one quartet of global foreign direct investment outflow is invested by developing and transition countries. The spread and importance of foreign direct investment varies from region to region. Early 1980's when FDI was becoming popular, the rate of FDI industries spread in Asia. This was in search of the cheapest labor which gave incentive for the increment of FDI in Asia. But these days the direction has shifted to other countries including Africa (OECD 2005).
Due to the recession since 2008 the world economy has declined by 2 percent. As a result the amount of FDI inflow in some part of the world was low. However, FDI inflow has recovered from 2010 onward. World investment report (2010) identifies the factors that influence future FDI inflow globally from 2010 onwards i.e macroeconomic factors, firm level factors, policy factors. Macroeconomic factors include gross domestic product, gross fixed capital formation, the interest rate and commodity prices. Firm level factors are profit and liquidity position (cash holding). Yet, risks and uncertainties such as instability of global financial system (high inflation and instable exchange rate) may affect FDI inflow negatively (UNCTAD 2010).
Figure 3.3 shows that the share of FDI flows in different part of the world. When we see the trend of FDI inflow to Africa during 1980 - 1989 the share from developing countries increased from 9 percent during 1980-1984 to 12 percent during 1985 -1989. In 1989 the amount of FDI inflow was 4.3 billion dollar. However, oil producing countries accounted
86 percent of total amount. Since 1981, the inflows of FDI for non oil exporting sub- Saharan Africa have been below 0.5 billion dollar which is very low compared to other parts of the world. As world investment report (1991) stated except oil exporting country, Nigeria, the main recipient of FDI, most sub-Saharan Africa's FDI inflow is low due to deteriorating business conditions and political instability (UNCTAD 1991).
Figure 3.3 Share of FDI inflow (percentage of total world) Source: UNCTAD Database/UNCTADStat
UNCTAD (2011) report indicated that while inflow of FDI decreased in the northern
Africa due to insatiability, sub-Saharan Africa FDI inflow increased from $29 billion in
2010 to $37 billion in 2011 (UNCTAD 2011). The report stated that the amount of Sub- Saharan Africa inward FDI is recovering. Figure 3.4 shows the inflow of FDI to Sub- Saharan Africa from year 1970 to year 2010.
Figure 3.4 FDI inflow to Sub-Saharan Africa ($ in millions)
Beside developed countries, developing Asian countries have significant contribution for
FDI inflow to Africa countries. As can be seen in the table 3.1, the share of developing
economies increased from 17.7 during 1995-1999 to 20.8 during 2000-2008. India and Malaysia next to china are the major sources of FDI inflow to sub-Saharan Africa. While some FDI are Market and efficiency seeking investment, most FDI to Africa from developing countries are resource-seeking especially natural resources. Since FDI from developing Asia is labor intensive manufacturing it generates employment to African countries. Mostly China and India investors are involved in manufacturing and infrastructure (UNCTAD 2010).
Share in World Total (%)
Inflows
Inward stocks
1995-1999
2000-2008
1999
2008
Total world
100
100
100
100
Developed countries
79.0
72.1
89.0
91.6
Developing economies
17.7
20.8
6.9
7.4
South-East Europe and
Commonwealth of Independent
States
0.3
0.0
0.0
0.0
Unspecified
3.0
7.1
4.1
1.0
Table 3.1. Distribution of estimated inward FDI and stock in African countries by source region
Source:- UNCTAD 2010
3.6 FDI policy framework in Sub-Saharan Africa
The bad image of Africa due to civil war, political instability, poor economic performance, poverty, disease, had negative impact on FDI inflow (UNCTAD 1999b). Due to these reasons, multinational enterprises didn't consider African countries as favorable location for investment despite the fact that most countries are at peace and political stability.
Since 1980's most African countries had been working hard to bring political stability and economic development. For most of them the gross domestic product per capital had shown significant increment. Odenthal (2001) indicated that African countries have had policy reforms from the late 1980s onward. The FDI policy reforms include political and economic reform such as macroeconomic stabilization, trade and investment liberalization, privatization, reduction of bureaucracy (Odenthal 2001).
During 1988 more than 20 sub Saharan African countries had done FDI policy reform. And they became open for international trade and foreign investment by creating business friendly environment. As a result, the FDI inflow increased during 1990's compared to
1980's. It is believed that FDI has significant contribution for economic development in sub Saharan African countries.
Like other African countries, Sub-Saharan Africa countries signed international agreements to deal with FDI issues. This includes bilateral investment treaties (BITS) (agreement between the host and foreign country to put terms and condition that both counties follow to create smooth relationship), Double taxation treaties (DTTS)(to avoid double taxation), and multilateral agreements (to settle investment disputes and FDI protection).
In Africa the Southern African Development Community (SADC) was formed by 14 member countries in order to create free trade zone (Jenkins 2001). All members of the SADC are Sub-Saharan Africa countries.
