China’s Outward Foreign Direct Investment Impact on Economic Growth in Developing Countries: Empirical Evidence from Ghana
Foreign direct investment (FDI) is one of the economic growth stimulus due to its associated variables such as capital investment, technical know-how, knowledge transfer and managerial competence required for economic growth. In the last decade, China has emerged on the international financial scene as both financier and investment partner to African economies. Many African economies such as the oil producing and exporting ones have witnessed streams of China’s FDI in their economies whereas non-oil exporting ones have accessed some of China’s FDI in selective sectors. This paper aims at investigating the relationship between China’s FDI and economic growth in Ghana measured by real average annual domestic product (GDP) per capita growth for the period 2001-2010. By using ordinary least squares (OLS) regression model, the result indicates that China’s FDI has negative significant effect on Ghana’s economic growth. However, it exerts different effects on value added in the three economic sectors.
Keywords: China, FDI, Ghana, GDP growth per capita
JEL Classification: F21, F36, F43
According to International Monetary Fund (1993) definition as contained in the Balance of Payment Manual Fifth Edition, foreign direct investment (FDI) refers to an investment made to acquire lasting interest in an enterprise operating outside of the economy of the investor. It is undoubtedly true that FDI has been playing increasing role in the three major economic groupings – developed countries, developing countries and the transition economies of South-East Europe and the Commonwealth of Independent States (CIS). World Investment Report (2008) indicated that global FDI inflows increased by 30 percent to reach a record high of US$1,979 billion in 2007. The story was not the same in 2008 as global FDI inflows declined by about 14 percent to US$1,697 billion. The downward trend continued through 2009 with US$1,114 billion however, there was a slight increase of 5 percent in 2010 to reach US$1,169 billion. According to the report, the 2007 FDI growth was largely due to relative high economic growth and strong corporate performance in many parts of the globe especially in developing countries. Foreign direct investment inflows to developed countries reached US$1,248 billion with the United States maintaining its position as the largest recipient country followed by the United Kingdom, France, Canada and the Netherlands. FDI inflows to developing countries amounted to US$500 billion indicating a 21 percent increase over 2006 and also the highest level ever reached by these economies. The least developed countries (LDCs) attracted US$13 billion worth of FDI in 2007 – also a record high. At the same time, developing countries continued to gain in importance as sources of FDI, with outflows rising to a new record level of US$253 billion, mainly as a result of outward expansion by Asian TNCs. Foreign direct investment inflows into South-East Europe and the CIS also surged, increasing by 50 percent, to reach US$86 billion in 2007. The region has thus seen seven years of uninterrupted growth. Outflows from this region similarly soared to US$51 billion, more than twice the 2006 level. Among developing and transition economies, the three largest recipients were China, Hong Kong (China) and the Russian Federation.
In Africa, FDI inflows grew to US$53 billion in 2007 – a new record. Booming commodity markets, rising profitability of investments – the highest among developing regions in 2006-2007 – and improved policy environments fuelled inflows. Least developed countries in Africa also registered another year of growth in their FDI inflows. A large proportion of the FDI projects launched in the region in 2007 were linked to the extraction of natural resources. The commodity price boom also helped Africa to maintain the relatively high level of outward FDI, which amounted to US$6 billion in 2007. Despite higher inflows, Africa’s share in global FDI remained at about 3 percent. Transnational corporations (TNCs) from the United States and Europe were the main investors in the region, followed by African investors, particularly from South Africa. TNCs from Asia concentrated mainly on oil and gas extraction and infrastructure.
The daunting task of the 2008 financial and credit crisis has reshaped the distribution of global FDI (UNCTAD, 2011). Developing and transition economies have emerged as the new FDI powerhouses both as recipients and as outward investors. For the first time in 2010, they absorbed more than half of global FDI inflows and occupied half of the top-20 host economies for FDI inflows. Their outflows also increased strongly by 21 percent accounting for 29 percent of global FDI outflows thereby granting them six spots on the list of global top-20 investors. The trend was not different from 2011 as both developing and transition economies accounted for 45 percent and 6 percent respectively of global FDI (total of US$777 billion compared to US$748 billion received by developed countries). As part of the risk factors contributing to the reshaping of global FDI landscape are the unpredictability of economic governance, a possible widespread of sovereign debt crisis and fiscal and financial sector imbalances in some developed countries. On the other hand, economic dynamism and strong role being played by both developing and transition economies in international economic development during and aftermath of the global financial and economic crisis of 2008-2009 has been beneficial to these economies.
Regional contribution of increasing FDI to developing countries was powered by a 10 percent increase in Asia, 16 percent increase in Latin America and the Caribbean whereas transition economies increased by 25 percent to reach US$92 billion. However, Africa continued its downward trend for a third consecutive year (4.4 percent equivalent to US$52.6 billion in 2009; 3.3 percent equivalent to US$43.1 billion in 2010; 2.8 percent equivalent to US$42.7 billion in 2011). Even though Africa continues to attract marginal percentage of global FDI flows, distribution is skewed towards resource endowed countries like Angola, Egypt, Nigeria and South Africa which accounted for 61.99 percent of total FDI inflows to Africa in 2008. The pattern flow of FDI into Sub-Saharan Africa is much more of resource seeking as it is evident in the oil-rich countries like Angola and Nigeria. The discovery of oil deposits in commercial quantities and value have accorded Ghana great potential of moving from a predominantly import-dependent country to an export one with streams of FDI flowing into the economy.
Ghana is one of the nation states in West Africa and due to its political tolerant, its usually referred to as the “Gateway to Africa”. The stable political atmosphere in Ghana has prompted the country to actively embrace the policy strategy prescribed by the international organizations such as International Monetary Fund (IMF) and World Bank. The country’s market reform which began in the early 1980s has promoted the private sector as the principal engine of growth. Ghana’s policy objectives continue to be shaped by the country’s structural adjustment programme and market orientation launched in 1983. The combination of both structural and macroeconomic reforms since 1984 has reflected in the country’s sustained output growth and increased private sector activity and investment over the past three decades. According to IMF data, as at 2005 Ghana’s gross domestic product (GDP) and per capita income were US$10.7 billion and US$484 respectively. By 2011 the country’s GDP and per capita income had increased to US$82.571 billion and US$3,256.848 respectively. During the past three decades, the annual economic growth rate in the country has averaged over 8 percent (4% in 2009, 7.7 in 2010, 13.5 in 2011). These numbers continue to keep the country’s dream alive which was formulated in its Vision 2020 plan, “Seeking to transform the economy into a middle-income country by the year 2020”. Sectors contribution to GDP as at 2010 were services (48.5%), industry (25.9%) and agriculture (25.6%). All things being equal, the given indicators indicate that the presence of prospective FDI in the Ghanaian economy, irrespective of where its coming from should contribute positively to the Ghanaian economic growth.
The paper is organized as follows: section two deals with theoretical review on the study of FDI and economic growth whereas section three looks at FDI trend and performance in Ghana. Section four takes a closer look at the performance of China’s outward FDI in different sectors of the Ghanaian economy. Empirical analysis of China’s FDI and Ghana’s economic growth is conducted in session five whiles the last section presents conclusion.
2. Literature Review on FDI and Economic Growth
According to Alemayuhu (2002), the theory regarding the determinants of FDI encompasses a wide range of thoughts including the product cycle theory (Vernon, 1966; Krugman, 1979), the pure capital movement theory (Iversen, 1935 and Tobin 1958 both cited in Agarwal, 1980; MacDougal, 1960) and the stagnation thesis of radical economists (Baran and Sweezy, 1966; Magdoff, 1992). However, as discussed by Jenkins and Peters (2006) it is important to access FDI with regards to motivation such as market-seeking, natural resources-seeking or efficiency-seeking. This is very important from Sub Sahara African studies perspective since it helps to bring to bear the relative importance and purpose of FDI from both Chinese and Western sources. According to Zafar (2007) and UNCTAD (2007), China’s FDI in Africa which was about $20 million per year in the early 1990s reached over $1 billion in 2006. By contrast, its time frame and source makes it different from Western and Japanese FDI. It is sometimes explicitly or implicitly linked to achieving strategic objectives than focusing on profit maximization.
Foreign direct investment and its transmission into growth has attracted a number of studies. Theoretically, models of endogenous growth has been combined with research work on technology diffusion to lay emphasis on the important role played by FDI in an economy (Lucas, 1998; Barro, 1990). Findlay (1978) argued that foreign direct investment increases the rate of technological progress in the host country through contagion effect from the more advanced technology and management practices used by foreign affiliates. Blomstrom et. al., (1994) reported that FDI exerts a positive effect on economic growth, but that there seems to be a threshold level of income above which FDI has positive effect on economic growth and below which it does not. It further explains that new technologies and FDI benefits from technology diffusion can only be absorbed by countries that have reached a certain level of income. Their earlier study unearthed human capital as one of the reasons for the differential response to FDI at different income levels as it takes well-educated population to understand and spread the benefits of new innovations within an economy.
A number of available literature also show that there is a positive relation between FDI, domestic investment and GDP growth (Glass and Saggi, 1998). Bosworth and Collins (1999) showed in their analysis of 58 developing countries over the period 1979-1995 that an increase in capital inflows (especially FDI) is associated with an increase in domestic investment with an estimated coefficient close to one. This signifies that FDI as one of the components of capital flows brings about a one-to-one increase in domestic investment indicating a contribution to growth. Borensztein et. al. (1998) found that a one percentage point increase in the ratio of FDI to GDP in developing countries over the period 1970 – 1989 was associated with a 0.4 to 0.7 percentage point increase in the GDP per capita growth, with the impact varying positively with educational attainment as an indicator of a country’s ability to absorb technology.
De Gregorio (2003), while contributing to the debate on the importance of FDI, notes that FDI may allow a country to bring in technologies and knowledge that are not readily available to domestic investors, and in this way increases productivity growth throughout the economy. FDI may also bring in expertise that the country does not possess, and foreign investors may have access to global markets. In fact, he found that increasing aggregate investment by 1 percentage point of GDP increased economic growth of Latin American countries by 0.1% to 0.2% a year, but increasing FDI by the same amount increased growth by approximately 0.6% a year during the period 1950–1985, thus indicating that FDI is three times more efficient than domestic investment.
Markussen and Vernables (1998), discussed that the impact of FDI on economic growth is realized through trade. Dees (1998) postulates that FDI has been a major contributing factor in China’s economic growth. In their empirical work to study the relationship between FDI and economic growth in Malaysia for the period 1970-2005, Wai-Mun et. al. (2008) found out that a 1 percent increase in FDI resulted in 0.046 percent increase in Malaysia’s economic growth and 0.045 percent growth increase in real gross national investment.
The above literature indicate that all things being equal well guided Chinese FDI, being it public or private, would lead to growth in the Ghanaian economy thereby bringing about poverty reduction through job creation and income generation. As one of the aims of the paper is to investigate the impact of China’s outward FDI on Ghana’s economic growth, an empirical analysis would be conducted to determine the relationship between China’s FDI in Ghana and the country’s GDP growth per capita for the period 2001-2010 using time series data. The testing hypothesis is that China’s outward FDI flows have positive relationship with the level of real GDP growth per capita in Ghana. Real GDP per capita is a good indicator for assessing the standard of living in an economy. The study employs ordinary least square (OLS) regressions whereas the empirical analysis would be conducted using annual data from China’s Ministry of Commerce (MOFCOM) for the FDI flows, the real GDP growth per capita data from United Nations Conference on Trade and Development (UNCTAD) and the total trade data from UN COMTRADE.
3. Inward FDI Trend and Performance in Ghana (FDI Performance Index)
Free flow of capital across country borders allows capital to seek out the highest rate of returns and according to Feldstein (2000), comes with several advantages which include reduction of risk faced by owners of capital thereby enabling them to diversify their investment and lending portfolios; limitation of the abilities of governments to pursue bad policies; and the spread of best practices of corporate governance, accounting rules and legal traditions. In addition to Feldstein, Razin and Sadka (2001) observed that host countries gains from FDI can take several forms:
i) FDI contributes to human capital development in the recipient countries as a result of employee training in the course of operating new businesses.
ii) Profits generated by FDI contribute to corporate tax revenue in the host country.
iii) FDI allows for technology transfer, spillover and promotes competition in the domestic input market.
 Barry Bosworth and Susan Collins, 1999, “Capital Flows to Developing Economies: Implications for Saving and Investment”, Brookings Papers on Economic Activity: 0 (1), pp. 23-25.
 Borensztein, Eduardo, Jose De Gregorio, and Jong-Wha Lee, 1998, “How Does Foreign Direct Investment Affect Economic Growth?” Journal of International Economics, 45, pp. 115-135.
 Razin Assaf and Efraim Sadka, 2001, “Labor, Capital and Finance: International Flows”, Cambridge University Press.