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UNCTAD study weighs impact of FDI on African development

12 September 2005

The contents of this press release and the related Report
must not be quoted or summarized in the print, broadcast
or electronic media before 13 September 2005, 17:00 GMT

In its 2005 report on "Economic Development in Africa: Rethinking the Role of Foreign Direct Investment"(1) , released today, UNCTAD suggests that a focus on attracting FDI may be a poor guide to development policy and in some circumstances may actually distort long-term growth potential. If Africa is to benefit from its natural resource abundance and reverse premature deindustrialization a more balanced policy approach will be required.

A New Deal for Africa

Over the past months the debate on tackling poverty in Africa has made great strides: on a debt write-off, doubling aid, pruning conditionalities and building mutual trust and responsibility - all recommended in past UNCTAD reports - are now accepted parts of the policy package needed to deliver on the UN´s Millennium Development Goals. Britain´s Prime Minister Tony Blair has talked of an historic opportunity to make poverty history. But history has a habit of repeating itself in unexpected ways. In the past, foreign firms steered a development course for Africa at odds with local needs; today, attracting them is often presented as the region´s assured path to economic renewal.

FDI, the Report says, has become the "development finance of choice" for many African countries on the expectation that it will fill investment gaps without adding to external indebtedness, and that it promises a host of other benefits such as jobs, export opportunities and new technologies. But despite a major policy effort, including liberalization, privatization and deregulation - all recommended for attracting FDI - the continent has received a very small portion of global flows; a little over an annual average of 2% of those flows between 2000-2004, as compared to 4.4% in the 1970s.

Open for business

Starting with the small volume of FDI in Africa, governance failures have been taken as symptomatic of a hostile environment towards foreign business, closing Africa off from new growth opportunities. Redesigning macro, trade and industrial policies to open Africa to business is the remedy prescribed by structural adjustment programmes.

But the idea that openness to foreign firms will transform Africa´s investment climate is not confirmed by the adjustment record of the past 20 years. Those adjustment programmes, the Report suggests, "have done little to alter the region´s pattern of structural change and positive integration into the global economy" and "have failed singularly to re-establish a pro-investment and pro-employment economic climate". These, more than governance failures, have constrained and distorted FDI flows to Africa, it says.

In fact, the Report concludes that it is wrong to look at Africa as an outlier in the FDI story; market size, growth prospects and export structure are what ultimately matter in capturing more FDI. And assumptions that FDI is bolted down in machinery and equipment, brings large technological spillovers and crowds-in local investment need to be carefully evaluated, in situ, if irrational expectations (and disappointments) about what FDI can contribute to development are to be avoided.

The yoke of history

While many of the reforms of the 1980s and 1990s are undergoing revision, attracting more and more FDI has persisted as one of the durable legacies of the neo-liberal approach to development, the Report maintains. The idea that FDI responds to, rather than creates, success has met with resistance and the notion that it might carry costs as well as benefits almost completely ignored.

But the FDI challenge in Africa predates the crisis of the 1980s. Colonial histories left small markets and a lopsided position in the international division of labour. FDI flows were heavily concentrated in terms of both home and host countries, largely attracted to enclaves of export-oriented primary production using imported technology and intermediate inputs. This, the Report finds, has proved a persistent legacy; up to 80 % of annual flows in the 1990s were still going to the primary sector, when other developing regions were moving in a different direction.

The Report concludes that these persistent structural biases along with macroeconomic constraints have locked in an FDI regime with low value added, limited reinvested earnings and periodic profit surges. Moreover, inflows have been volatile, responding to external market conditions and corporate pressures.

And the combination of resource-oriented and volatile FDI has not changed with the recent revival of flows. Indeed, mergers and acquisitions, including one-off privatizations of public services (totalling some $34 billion between 2000-2004) have, in some years and countries, accounted for over half of flows, adding further to their volatility.

A new scramble for Africa

The recent surge of FDI to Africa, reaching over $18 billion in 2004, triple the annual average for the 90s, is largely due to increased demand for fuels and minerals; all but one of the top 10 recipients in 2003 had significant mineral and petroleum reserves.

As described in the Report, efforts to redraw the boundaries of the extractive sector by withdrawing the state and extending incentives to TNCs have certainly attracted greater FDI inflows, including M&As of almost $3 billion in 2004. Favourable price movements, new markets (including in developing countries) and more astute policy makers have raised expectations that these sectors offer better development prospects than in the past, encouraged by higher prices which account for better growth performances in the region. The Report warns against misplaced optimism. Whether or not increased competition among African countries in providing generous tax and other incentives to investors in the extractive sector becomes a "race to the bottom" depends on the successful management of the resource commons.

Reconciling broader development goals with narrow corporate interest has focused on augmenting government revenues by lowering taxes and raising export volumes. Drawing on the recent FDI-led gold booms in Ghana and Tanzania, the Report concludes that "supply-side" logic is unlikely to deliver; fiscal revenues dipping to as low as 5% of export values, low value added and modest net foreign exchange earnings have been the norm. And this experience has been repeated in expanding oil and gas sectors elsewhere in Africa.

The danger of locking in to enclave-type development is a real one, and not only in the extractive sectors; particularly where low wages, fiscal incentives and devalued currencies are used to enter the production networks of TNCs, high import dependence brings attendant balance of payments problems. The report shows that in a number of African countries profit remittances have in recent years exceeded total FDI inflows, sometimes by many times over.

Balancing cost and benefits

The idea that Africa is a reluctant host to foreign capital is a myth. On the contrary, the Report notes, attracting FDI has become the industrial policy of choice for many governments, with incentives for foreign firms amounting to a kind of subsidy, displacing policies to nurture local firms and encourage domestic investment.

A more balanced framework needs to weigh up country- and sector-specific costs and benefits: the inflow of capital from FDI may be a benefit but the resulting outflow of profits may be so high as to make it a substantial cost; production of firms is a benefit but less so if it displaces local firms; extra exports may require a considerable increase in imports, with uncertain outcomes on the balance of payments.

Failure to consider these costs can orient the incentive structure towards quick returns, speculative investments and short-term horizons; the oft-touted high profits on FDI in Africa reflect its concentration in the capital-intensive extractive sectors where rents (and risks) are particularly high. Domestic capital accumulation, including in the public sector, must be revived and thresholds with respect to industrial capacity, skill levels and infrastructure development will have to be crossed before FDI begins to work harder for development, the Report says.

Rethinking policies

Policies to attract more FDI through a further push for rapid liberalization and downsizing the state will not do the job. A rethink is needed. The Report suggests a multi-dimensional approach:

  • Take the cost-benefit perspective seriously; gauge the impact of FDI on local costs and profitability, the size of spillovers and linkages and the extent of import dependence and profit repatriation. In extractive industries, environmental and social costs also need to be fully factored in;
  • Mix and sequence strategic industrial policies, including the use of performance requirements, differential taxation and barriers to takeovers, aimed in particular at using FDI to diversify into non-traditional exports;
  • Further process resource-based exports at the domestic level in order to create value added and deepen industrial capacity;
  • Enhance macropolicy space, including inter alia selective capital controls, fiscal incentives and monetary policy autonomy, to give priority to domestic capital formation; and
  • Harness FDI to ODA-led infrastructure programmes to galvanize a big financing push.

Regional trading arrangements can help expand exports. Larger markets can also attract FDI, including from other developing countries, and can improve bargaining with TNCs through harmonized policies, coordinated tax and other incentives, and improved monitoring of corporations. The Report suggests that extractive industries provide a good place to strengthen regional policy coordination. A fresh look at the East Asian experience where industrial policies, FDI and regional dynamics were, to varying degrees, part of a late industrialization drive could also offer useful lessons.

The Report also calls for a rethink of the international FDI agenda, particularly where policy space has been constrained in the hope of attracting greater flows. Such a reassessment might usefully begin by mapping the full range of options available to better manage the costs and benefits of hosting FDI, with technical assistance programmes redesigned to better manage integration in light of local needs. The Report suggests paying particular attention to conditionalities on multilateral lending where "means" have trumped "ends" in designing policies towards FDI. But getting policy coherence right also means focusing on bilateral and regional initiatives, which often push beyond multilateral agreements, and on the tenuous promise of bringing more FDI.

Downloads [PDF]: | Full report | [PDF, 115 Pages, 548Kb]


1. The Economic Development in Africa: Rethinking the Role of Foreign Direct Investment 2005 (Sales No. E.05.II.D.12, ISBN 92-1-112671-1) may be obtained from UN sales offices at the addresses below or from UN sales agents in many countries. Price US$ 19.00. Please send orders or enquiries for Europe, Africa and Western Asia to United Nations Publication/Sales Section, Palais des Nations, CH-1211 Geneva 10, Switzerland, fax: +41 22 917 0027, e-mail: unpubli@un.org ; and for the Americas and Eastern Asia, to United Nations Publications, Two UN Plaza, DC2-853, New York, NY 10017, USA, tel: +1 212 963 8302 or +1 800 253 9646, fax: +1 212 963 3489, e-mail: publications@un.org . Internet: http://www.un.org/publications .

For more information, please contact:
UNCTAD Press Office
T: +41 22 917 5828
E: unctadpress@unctad.org
Web: www.unctad.org/press
or: K. Kousari
T: +41 22 917 5800
E: kamran.kousari@unctad.org


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