The Steinhoff Saga Management review - University of Stellenbosch Business School

January – June 2019

Will infrastructure unlock the investment potential of Africa?

By Linda Velenkosini Buthelezi

  • June 2019
  • Tags Features, Finance
15 minutes to read

SHARE

The link between FDI and a solid infrastructure

Africa has been known for its lack of basic infrastructure development. But the critical question is: To what extent does infrastructure development impact growth in foreign direct investment in Africa? It is hypothesised that adequate infrastructure improves the efficiency of a country and lowers the cost of doing business, thus attracting the flow of investment funds.

This paper investigated the relationship between infrastructure development and foreign direct investment in Africa spanning 30 countries between 2003 and 2016. The period under review includes the global economic crisis. The countries represented all the regions of the continent – Southern, Western, Eastern and North Africa.

Utilising the Africa Infrastructure Development Index (AIDI), which ranks countries based on their infrastructure development, the study is one of the first to measure the link between foreign direct investment (FDI) and the development of water supply and sanitation, information and telecommunications technology (ICT), energy and transport as published annually by the AIKP and the African Development Bank.

FDI comes in various forms – including opening a subsidiary … in another country, acquiring a controlling equity interest in an existing foreign company, or facilitating a merger or joint venture with a foreign company.

Why does Africa rely on FDI?

A well-established domestic financial and capital market sector is crucial for sustained economic growth in any country. However, in developing countries, no such markets exist which presents critical challenges to growth and stability. And even if they do exist, there are not enough local investors with the capacity to take advantage of the economic opportunities available. This forces these countries to rely on a flow of capital from developed markets by means of remittances, donor funds, foreign direct investments, equity funds, bond funds, investment portfolios and/or other forms.

For the purposes of this paper, FDI is regarded as the investment made to acquire a lasting interest in enterprises operating outside the investor’s home economy. FDI comes in various forms – including opening a subsidiary or an associate company in another country, acquiring a controlling equity interest in an existing foreign company, or facilitating a merger or joint venture with a foreign company. FDI can also include the provision of project finance or facilitating the transfer of technology and managerial skills from the source country.

The need for FDI is driven by factors such as political and economic institutions of governance, level of infrastructure, openness to trade, economic freedom, labour markets, import and export opportunities, skills levels, macro-economic stability, proximity to important markets, market size, and the availability of natural resources. However, high inflation, political instability and conflict do deter FDI.

Unlike other investment types, FDI invests in physical capital and is therefore partially irreversible as much of the costs associated are irretrievable should the firm decide to disinvest.

Between 2010 and 2016, on average, the FDI inflow into the sample of 30 African countries equated to 4% of GDP annually with the highest FDI recorded at 45.8% and the lowest at 0%. GDP grew by an average of 4.9% which is higher than the world average has been for several years. The average GDP per capita was US$2,211.876, with the lowest at US$173.9164 and the highest at US$10,716.22.

During this time, FDI was not entirely dominated by investments in mining and extractive industries but rather by investments in technology, media and telecommunication, retail and consumer products and financial services. Private investment opportunities have also emerged in infrastructural sectors such as education, healthcare and security which were previously highly dominated by the public sector. This diversification has provided a division of economies in some markets, where the haves use private services and the have-nots use the mostly inadequate and inefficient public infrastructure that is beset by delays and interruptions in service provisions. Some countries, though, have managed to improve public infrastructure to a level where it directly competes with private infrastructure.

FDI … assists the recipient country to import technology and thereby catch up with economically developed countries

However, the consistency of FDI and the monitoring of trends are problematic. For example, a country’s level of FDI may be positively affected by a large investment into a well-established entity, which results in the FDI for that year being a deviation from the average. Large single transactions unlikely to be repeated will show a significant decline in the following year. FDI is also impacted by global investment trends. The United Nations Conference on Trade and Development reported that FDI fell by 13% in 2016 as global economic growth remained weak and world trade volumes posted poor gains.

The benefits of FDI

Countries have been trading with one another for many centuries as economies need to export goods and services to generate revenue with which to finance imported goods and services that cannot be produced domestically. To leverage comparative advantages in other countries, some companies move their production plants across borders or invest in countries where they can make a profit. Developing countries, on the other hand, need FDI to augment domestic economic growth and to bridge the financial gap.

Unlike other investment types, FDI invests in physical capital and is therefore partially irreversible as much of the costs associated are irretrievable should the firm decide to disinvest. It assists the recipient country to import technology and thereby catch up with economically developed countries, boosting the country’s infrastructure stock through the facilitation of newer, faster and more productive technology.

A new trend has therefore emerged where governments seek investment in private infrastructure

Inhibiting factors to international investment include unreliable energy provision, the high cost of transport and non-functional utilities – although these can be promoting factors if they function efficiently. A new trend has therefore emerged where governments seek investment in private infrastructure projects from multilateral institutions to reduce the perceived risks of some projects or to encourage FDI investors pursuing a project in the area to invest in the lack of infrastructure to support their operations.

The impact of infrastructure on FDI

Infrastructure refers to the basic physical and organisational structures and facilities integral to the social, political and economic life of any nation. It includes assets such as buildings, roads, power supplies and ICT, and enables not only the well-being of the society that benefits from it but is increasingly becoming an important base on which to build economic development.

Economic infrastructure refers to the physical infrastructure such as transport, energy, communications, water and sanitation, while social infrastructure refers to health, education, commercial and security or defence.

Africa is faced with a significant infrastructure deficit. Infrastructure is mainly concentrated in urban areas or near big cities. Even then, outdated and inadequate urban plans fail to take into account the social, political, economic and environmental contexts of urban development in Africa.

Of the 674 million people worldwide without access to electricity, 90% are in sub-Saharan Africa. Energy has a positive and statistically significant effect on FDI inflows.

At present, Africa’s ability to attract FDI is hampered by the following in particular:

  • Energy: Sub-Saharan Africa consistently ranks low in terms of energy production compared to other developing regions. The entire continent produces less than 100 gigawatts of power. Of the 674 million people worldwide without access to electricity, 90% are in sub-Saharan Africa. Energy has a positive and statistically significant effect on FDI inflows. However, Africa’s unreliable power and water supply and the high cost of transport make it difficult for international investors to manufacture and produce efficiently on this continent.
  • Transport: Transport infrastructure is found to be less developed than other types of infrastructure with some countries indicating close to zero transport infrastructure development. It is further interpreted that an increase in air transport (passenger and freight), more kilometres of tarmacked road as a percentage of the total road network, more kilometres of railway lines, and adequate port infrastructure are key determinants in attracting FDI into a country.
  • ICT: One of the categories of infrastructure that has greatly improved over the last 10 years is information and telecommunications with $25 billion invested by private investors and operators between 1995 and 2005. Mobile telephone services in particular leapfrogged other infrastructure sectors. Hence, in some regions, the number of people with access to adequate water and sanitation is less than one in three, yet more than 90% have access to mobile telephony services. The higher the ICT development, the more efficient the economy, contributing to productivity and economic growth indirectly by attracting more FDI. However, most of the developing countries lack ICT infrastructure, which is enormously costly for locals and first needs to be built up to get to the level where it can help to attract FDI.
  • Water supply and sanitation: This has an important role in attracting FDI. The United Nation’s Sustainable Development Goals state that the lack of access to improved water supply and sanitation services imposes high costs on society, especially the poor. Yet despite the importance of water for development, 82% of governments have indicated that financing was not enough to reach national targets for drinking water.

… in some regions, the number of people with access to adequate water and sanitation is less than one in three, yet more than 90% have access to mobile telephony services.

The African region is known as a net recipient of FDI capital flows. Investments lead to possible imports of associated machinery and equipment, as well as the export of the projects’ outputs as operations begin, and as profits and invested capital are repatriated as the project matures. FDI flows have an impact on a country’s balance of payments since most FDI investments are accompanied by imports and exports into and out of the country.

This study found that few countries had consistently high FDI inflows over the reporting period. In countries where FDI exceeded 10% of GDP, this was due to investment in oilfields by the major oil companies and China’s investment in rail, road and port infrastructure.

Countries with higher levels of GDP per capita attract higher levels of FDI, particularly as they can attract better skills and benefit from production factors, better education and adherence to the rule of law.

What does the future hold for FDI in Africa?

African governments should continue to focus on the development of their economies to ensure that their economies grow faster than their populations. The implementation of the Sustainable Development Goals should be the focus of every country on the African continent. The large number of African countries in the low-income category is one of the factors making it difficult to attract meaningful FDI, even as infrastructure development improves.

The large number of African countries in the low-income category is one of the factors making it difficult to attract meaningful FDI, even as infrastructure development improves.

  • This article is based on the MPhil in Development Finance research assignment of Linda Velenkosini Buthelezi. He is a graduate of the University of Stellenbosch Business School. His supervisor was Dr Ashenafi Fanta, senior lecturer in Development Finance and programme head of USB’s PhD in Development Finance.
5 Comments

Leave Your Comment

Featured articles

Jun 11

15 minutes to read

Will infrastructure unlock the...
Jun 11

20 minutes to read

The megaproject sponsor as lea...

Join the USB community

Receive updates on the latest news, events, business knowledge and blogs at USB.

SUBSCRIBE NOW