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FDI and Economic Growth: Does the Type of FDI Matter?

In one of our previous blog posts we wrote about the link between FDI and economic growth.[1] While it proved impossible to pin down an uncontested link, it still makes sense that FDI has an economic impact in the host economy. In this installment we try to answer whether the local impact of FDI depends on what kind of FDI it is and how this relates to sub-Saharan Africa.

Which one is better? Mining or...

...manufacturing?

The United Nations Conference on Trade and Development has specified several kinds of FDI: (1) natural-resource-seeking investment, (2) market-seeking investment, (3) efficiency-seeking investment, and (4) strategic-asset-seeking investment. Natural-resource-seeking investment involves FDI in the extractive sector.[2] Market-seeking FDI is any type of investment that seeks to serve the host market. Efficiency-seeking FDI occurs when companies move some of their business to another country to keep costs down. Strategic-asset-seeking FDI occurs when companies invest abroad to pick up new techniques and experience.

The local impact is likely to be different for each kind. Market-seeking FDI might lead to higher employment, but less trade. Whereas, efficiency-seeking FDI might lead to both more employment and more trade. In general, economists seem to agree that manufacturing industries are more wealth creating than commodities or services industries. Therefore, it is argued that FDI related to manufacturing will have a bigger impact on economic growth than extractive-sector FDI.[3] Research done on economic growth in China seems to underscore this point. [4] Unfortunately, extractive-sector FDI is one of the largest and fastest growing forms of FDI to sub-Saharan Africa.[5]

There are several reasons why extractive-sector FDI might be less growth enhancing than other types of FDI. Firstly, extractive sector FDI tends to hire much less domestic labour. Secondly, even though extractive-sector FDI usually leads to higher exports, the improved terms of trade are often used to finance more consumption and not investment.[6] Thirdly, you might remember from our previous blog that FDI impacts economic growth in the long run by improving the level of technology. The extractive sector, however, is very capital intensive and often operates as an enclave in the economy, both of which diminish the ability to transfer technology. Lastly, in our previous blog we indicated that one of the preconditions economic growth from FDI is strong local competition. Sadly, extractive sector industries are often monopolies due to their large economies of scale.

Most of the studies mentioned in our previous blog on economic growth did not differentiate between types of FDI.[7] The studies that do seem to support the argument that extractive-sector FDI is less growth enhancing. Enisan Akinlo, for example, found that the extractive-sector FDI to Nigeria had a positive but insignificant impact on growth only after a considerable time lag.[8]

In short, our research leaves us with the knowledge that extractive sector FDI has had limited ability to be growth enhancing in the past, while also currently being one of the largest and fastest growing types of FDI to sub-Saharan Africa. Is there anything businesses and governments can do to make extractive-sector FDI more growth enhancing in the future? That is the topic of our next blog.


[1] Available here: http://buildingmarkets.org/blogs/blog/2012/06/29/fdi-and-economic-growth-lies-damned-lies-and-statistics/

[2] United Nations Conference on Trade and Development. Foreign Direct Investment and Development. Geneva and New York, 1999. PP. 19­–25.

[3] A. Enisan Akinlo “Foreign Direct Investment and Growth in Nigeria: An Empirical Investigation.” Journal of Policy Modeling 26 (2004) 627–639; Jeffrey Sachs and Andrew Warner. “Resource Abundance and Economic Growth.” NBR Working Paper No. 5398 (1995); Oliver Morrisey. “FDI in Sub-Saharan Africa: Few Linkages, Fewer spillovers.” European Journal of Development Research 24 (2012) 26–31.

[4] Peter J. Buckley et al. “FDI, regional differences economic growth: panel data evidence from China.” Transnational Corporations 11 1 (2002) 1-28.

[5] United Nations Conference on Trade and Development. World Investment Report 2007: Transnational Corporations, Extractive Industries, and Development. Geneva, 2007. P. 39

[6] International Council for Mining and Metals. Utilizing Mining and Mineral Resources to Foster Sustainable Development of the LAO PDR. Resource Endowment Initiative, 2003. P. 8.

[7] Laura Alfaro. “Foreign Direct Investment and Growth: Does the Sector Matter?” Harvard Business School, 2003. Available here: <http://www.51lunwen.org/UploadFile/org201101310901063260/20110131090106459.pdf>.

[8] Enisan Akinlo. “Foreign Direct Investment.” P. 633.

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