FDI Determinants and the effect of FDI on Economic Growth of the East African Community (EAC)

This thesis comprises of three self-contained analytical chapters. We attempt to answer three key research questions on the determinants of foreign direct investment (FDI), FDI-growth nexus and income convergence in the East African Community (EAC) region.

Below are our three key research questions:

1. What are the determinants of FDI to the EAC region?

2. Does FDI contribute to the aggregate economic performance of the EAC region and what is the effect of FDI on the ratio tradeable output to non-tradeable output? Also, what is the contribution of ratio tradeable output to non-tradeable output on the economic growth of the EAC region?

3. Did the EAC region experience income and FDI convergence during the study period?

We are motivated to understand the key driver of FDI to the EAC region. These member countries have continued to witness an increase in the FDI activities from 1970 to 2017. Therefore, we want to investigate if the EAC member countries received market, efficiency or resource-seek FDI (Breham, 1972). Understanding these FDI types enable policy makers to attract the right FDI type that plays significant positive role on the host EAC region. Most study suggests that market seeking FDI has greater productivity spilover to local firms than resource or efficiency-seeking FDI (Borenzstein, et al. 1998). Also, data from Bank of Uganda and Bank of Rwanda shows that most FDI goes to service sector followed by manufacturing and with fewer foreign direct investment channelled to agricultural sector. The disparity of sectoral FDI to service, manufacturing and agricultural sector motivated us to empirically assess the sectoral role of FDI, and in addition to studying the contribution of different sectoral output on the economic growth of the EAC region.

To achieve our research objectives, we applied location theory to gain better understanding of different motives of FDI (i.e., market–seeking, resource–seeking, and efficiency–seeking FDI) to the EAC. Location theory is favoured because of it is easy to apply in context to our study, and more flexible to accommodate different variable of interests. In terms of the economic growth, our analytical framework is based on Solow (1956) growth model. The model allows us to empiricall capture the role of FDI on economic performance of the EAC region, in addition to assessing the income and FDI convergence in the region.

Our research objectives are based on lack of studies on the FDI determinants, FDI-growth nexus and income and FDI convergence in the EAC region. Therefore, our thesis seeks to fill the gap in the current literatures in the field of economic development. The data used in our study of the FDI determinants, FDI – growth nexus, and income convergence was mainly sourced from the World Bank database. These datasets range from 1970 – 2017. In addition, the bilateral FDI data from the year 2000 – 2017 that shows FDI from the UK to the rest of the EAC region (i.e., Uganda, Kenya, Tanzania, and Rwanda) were sourced from the UNCTAD database.

The report from our empirical investigation on the FDI determinants to the EAC region shows that the region received market, efficiency, and resource seeking FDI in the long-run vis-à-vis short-run period. And that resource and efficiency–seeking FDI are only attracted to the region in the face of trade liberalization. In terms of growth impact, empirical evidence indicates that FDI insignificantly contributes to economic growth at both aggregate and sectoral level. Furthermore, the study reveals that service sector output (the non-tradeable output) significantly supports economic growth of the EAC region from 1970 –2017 vis-à- vis the tradeable output (manufacture and agricultural sector output). We argue that this could be due to large amount of FDI flows to the non-tradable sector compared to the tradeable sector.

Finally, considering convergence, our study shows that from 1970 – 2017, FDI insignificantly supported beta convergence process in the region. Also, bilateral FDI data from the UK to the rest of the EAC region indicate that, from 2000 – 2017, bilateral FDI significantly contributed to beta and sigma convergence in the long-run. Conversely, we found insignificant short-run effect of bilateral FDI on beta and sigma convergence. Unsparingly, when language similarity is accounted for in our study, the result shows that income levels between the EAC region and the UK significantly reduces. We argue that language similarity promote trade and investment, in addition to facilitating technology transfer between the UK and the EAC region during the study period. Furthermore, there was evidence of stochastic FDI convergence in the region from 2000 – 2017.

We concluded our study by offering policy recommendations guided by our empirical evidence, coupled with the review of relevant empirical and theoretical literatures.