The History Of The Eclectic Paradigm

Published Date: 02 Nov 2017

Introduction:

Foreign Direct Investment is one of the most important factors in international economic integration and it takes place when at least ten per cent of a company shareholding in a domestic firm undertakes an investment in a foreign country. Its job consists of creating direct, stable and long-lasting links between economies while encouraging the transfer of technology and expertise between countries. It can also be regarded as an extra source of funding for investment and an important vehicle for enterprise development under the right policy environment. Foreign Direct Investment is viewed as the most stable component; owing to the nature and duration of the commitment it involves (Barrell and Holland, 2000). FDI is seen as a catalyst to the host nation’s economic growth and development as it enhances technological process and promotes industrial development (Asheghian, 2004).

Foreign direct investment takes two main forms; the first is a Greenfield investment, which involves the establishment of a new operation in a foreign country and the second one is through acquiring or merging with an existing firm in the foreign country.

According to the OECD, ‘Foreign direct investment (FDI) is the category of international investment that reflects the objective of a resident entity in one economy to obtain a lasting interest in an enterprise resident in another economy’.

Several potential benefits of foreign direct investment consists of technological spill overs, job creation, improved managerial skills and productivity (Mac Dougal, 1960 and Blomstrom and Kokko, 1997).Foreign investment is a major source of finance in developing ande developed countries.

According to IMF and OECD definitions, ‘the direct investment reflects the aim in obtaining a lasting interest by a resident entity of one economy in an enterprise that is resident in another economy.’

Theories of FDI

Hecksher-Ohlin Model

This model was first conceived by two Swedish economists, Eli Hecksher (1919) and Bertil Ohlin. This theory mainly argues about international differences in labour, labour skills, physical capital or land that create productive differences that explain why trade occurs. The model highlights that countries will export products that use their abundant and cheap factors of production and import products that use the countries scarce factors.

Other Authors such as Stephen Hymer (1976) and Kindleberger (1969) believed that there must be imperfections in the market for good or factors of production. Stephen Hymer focused on the multinational as an institution for international production and he asserted that foreign direct investment involved the transfer of resources. Firms choose to produce overseas to be able to benefit from favourable advantages that are not obtained in the host country. However Hymer confirmed that investment abroad involved high costs and risks to multinationals.

Another Author, David Ricardo tried to explain foreign direct investment through the comparative advantage theory which was based mostly on the Adam Smith theory. The theory was based on two countries; two products and perfect mobility of resources are considered. Ricardo explained that a country should specialise in the production of those goods that it produces more efficiently and to buy those good its produces less efficiently.

At a micro level, a frequently asked question among researchers is why firms prefer to service foreign markets through affiliate production instead of exports or licensing. Dunning stipulates four reasons for a firm to engage in such type of investment, easier access to resources, market access to market gains and acquisition of assets.

Companies increase their performance based on access to raw materials, new possible markets and increasing market share. Dunning (1988) acknowledge four stimuli for foreign direct investment, resources seeking, efficiency seeking and strategic asset seeking.

Resource seeking investments are companies which seek to acquire factors of production that are more efficient than those obtainable in the home economy of the firm. It also implies improving the feature of resources and promotes knowledge and capital intensive resource use. Market seeking refers to investments which target at either penetrating new markets or maintaining existing ones. Market seeking is mostly related to market size and market growth.

The third one is efficiency seeking, this one refers to the benefits obtained through economies of scale and the progress of improving human resources. Recent studies have recognized that firms invest in foreign country not only to exploit but also to develop their firm specific advantages or acquire necessary strategic assets in a host country.(Almeida :1996, Chang,1995.Dunning1993,1995,Frost 2001)

The Eclectic Paradigm

John Dunning, eclectic paradigm seeks to offer a general framework for determining the extent and pattern of both inward and outward foreign production. According to Dunning (1981, 1988), the eclectic theory provides a flexible and popular framework where there is three particular reasons why companies choose to go global, ownership, locational and internalization.

The Ownership advantages are regarded as advantage which firms develop in the home country. It allows a company to diversify its technologies, brand recognition and unique product qualities. The second advantage is locational advantage; firms seek in foreign countries for several reasons such as cheap resources, cheap labour, and favourable exchange rate, and regulations which are not available to the firm in the home country. The third advantage consists of Internalization which relates to benefits derived to company’s trade-off between FDI and exporting and licensing. Internalisation explains why a firm would rather choose a foreign market through FDI rather than pursue alternative modes without ownership control. It is why a ‘bundled’ FDI is preferred to an ‘unbundled’ product licensing, capital lending or technical assistance.(Wheeler and Mody, 1992).

Bradley (1999) argued that, if it is believed that a company has great and costless understanding from which benefit can be taken. Companies are generally born with a geographical scope limited to an area or a home country, but now this horizon has changed. Internal and external factors are the result of these changes. New product development, rising internal resource and administration devotion are the internal factors; strong competition, government regulations are examples of the external factors. Many companies increase their performance based on access to raw materials, new possible markets and increasing market share.

Authors such as Hymer (1976) (in Dunning, 1993) and Kindleberger (1969) (in Cleeve, 2008) believe that there must be imperfections in the markets for goods or factors of production for there to be FDI. Hymer (1976) also confirms that investment abroad involves high costs and risks inherent to the drawbacks faced by multinationals because they are foreign. These include the cost of acquiring information due to cultural and language differences and the cost of less favorable treatment by the governments of host countries.

Market Size and Growth

Market size is defined through the market volume and market potential. It is measured by GDP per capita and is considered as an important determinant used when determining foreign direct investment (Artige and Nicolini (2005).Jordaan (2004) mentions that foreign direct investment will move to countries with larger and expanding markets and greater purchasing power, where firms can potentially receive a higher return on their capital and by implication receive higher profit from their investments.

Charkrabarti(2001) states that the market-size hypothesis supports an idea that a large market is required for efficient utilization of resources and exploitation of economies of scale. As the market size grows, foreign direct investment increases and thus enables investors to benefit from economies of scale. This assumption has been quite popular and a variable representing the size of the host country market has come out as an explanatory variable in nearly all empirical studies on the determinants of FDI.

Schneider and Frey (1985), Tsai (1994) and Asiedu (2002) find a positive relationship between the foreign direct investment and GDP. A higher GDP per capita means better forecasts of foreign direct investment in the host country. According to Parletun (2008), when GDP is positive that is less than one percent, it implies an increase in the market size tends to attract more foreign direct investment to the economy. Ang(2008) finds that real GDP has a positive impact on FDI inflows and that growth rate of GDP exerts a small positive impact on inward FDI.Edwards (1990) and Jaspersen et al (2000) conclude that real GDP per capita is inversely related to FDI/GDP.

Trade Openness

Trade openness promotes the efficient allocation of resources through specialization and comparative advantage and competition in both national and international markets. It allows easier diffusion of knowledge and technology across countries. Moreover if less capital controls and liberal trade policies are applied, it thus attracts more foreign direct investment whilst restrictive policies would dissuade foreign direct investment (Onyeiwu and Shrestha, 2004).The ability to move capital in and out of a country is important for foreign investors

Trade to GDP ratio is frequently used to measure the importance of international transactions.

Charkrabarti (2001) states that there is mixed evidence concerning the significance of openness, which is measured by the ratio of exports plus imports to GDP, in determining foreign direct investment. The assumption is that most investment projects are directed towards the tradable sector, a country’s degree of openness to international trade should be a relevant factor in the decision. Jordaan(2004) claims that openness on foreign direct investment depends on the type of investment. If investments are market seeking then lesser restrictions on trade openness might have a positive impact on FDI.

Multinational firms engaged in export-oriented investments prefer to invest in a more open economy since increased imperfections that accompany trade protection generally imply higher transaction costs associated with exporting. Wheeler and Mody (1992) observe a strong positive support for the hypothesis in the manufacturing sector, but a weak negative link in the electronic sector. Kravis and Lipsey (1982), Culem (1988), Edwards (1990) find a strong positive effect of openness on FDI and Schmitz and Bieri (1972) obtain a weak positive link. Moreover a range of surveys suggests that a widespread perception of "open" economies encourage more foreign investment.

Labour Costs and Productivity

Productivity is a measure of economic efficiency which shows how effectively economic inputs are converted into output. Charkrabarti (2001) claims that wage as an indicator of labour cost has been the most contentious of all the potential determinants of FDI. Cheap labour helps in attracting multinationals but however the availability of skilled labour is also considered.

Human capital is found to be a relevant determinant that affects the level of productivity. Basically skilled labour sectors where the level of education improves, productivity increases and facilitates implementation of technological innovations (Brooks et al., 2010). So a significant positive relation of FDI can be expected.

Particularly for efficiency seeking FDI, the more skilled labour available, the more likely FDI will flow to a host country.Results range from higher host country wages discouraging inbound FDI to having no significant effect or even a positive association.

Goldsbrough (1979), Saunders (1982), Flamm (1984), Schneider and Frey (1985), Culem (1988), and Shamsuddin (1994) demonstrate that higher wages discourage FDI. Tsai (1994) obtains strong support for the cheap-labour hypothesis over the period 1983 to 1986, but weak support from 1975 to 1978. When the cost of labour is relatively insignificant (when wage rates vary little from country to country), the skills of the labour force are expected to have an impact on decisions about FDI location.

Political Risk / Political stability

The ranking of political risk among FDI determinants remains rather unclear. Specific proxyvariables (e.g. number of strikes and riots, work days lost) have proved significant in some studies; but these quantitative estimates can capture only some aspects of the qualitative nature of political risk.

Empirical relationship between political instability and FDI flows is unclear. For example, Jaspersen et al. (2000) and Hausmann and Fernandez-Arias (2000) find no relationship between FDI flows and political risk while Schneider and Frey (1985) findan inverse relationship between the two variables. Using data on U.S. FDI for two time periods, Loree and Guisinger (1995) found that political risk had a negative impact on FDI in 1982 but no effect in 1977. Edwards (1990) uses two indices, namely political instability and political violence, to measure political risk. Political instability (which measures the probability of a change of government) was found to be significant, while political violence (i.e. the frequency of political assassinations, violent riots and politically motivated strikes) was found to be insignificant.

Infrastructure

Infrastructure covers many dimensions ranging from roads, ports, railways and telecommunication systems to institutional development. Poor infrastructure can be seen as both an obstacle and an opportunity for foreign investment. For the majority of low-income countries, it is often cited as one of the major constraints. But foreign investors also point to the potential for attracting significant FDI if host governments permit more substantial foreign participation in the infrastructure sector.

High infrastructure quality usually demands developed network of roads, airports, seaports, supply of water and electricity as well as internet networks and telephones (Onyeiwu and Shrestha 2004:96). Countries with these characteristics would usually attract FDI flows therefore a positive relationship is expected between infrastructure quality and FDI inflow.

Jordaan (2004) claims that good quality and well-developed infrastructure increases the productivity potential of investments in a country and therefore stimulates FDI flows towards the country. According to Asiedu (2002) and Ancharaz (2003), the number of telephones per 1,000 inhabitants is a standard measurement in the literature for infrastructure development. However, according to Asiedu (2002), this measure falls short, because it only captures the availability and not the reliability of the infrastructure. Furthermore, it only includes fixed-line infrastructure and not cellular (mobile) telephones.

GDP Growth

Economic growth is the increase in the amount of the goods and services produced by an economy over a certain period of time. It is mostly measured as the per cent rate of increase in real gross domestic product. The role of growth in attracting FDI has also been the subject of controversy. Charkrabarti (2001) states that the growth hypothesis developed by Lim (1983) maintains that a rapidly growing economy provides relatively better opportunities for making profits than the ones growing slowly or not growing at all. Lunn (1980), Schneider and Frey (1985) and Culem (1988) find a positive effect of growth on FDI, while Tsai (1994) obtains a strong support for the hypothesis over the period 1983 to 1986, but only a weak link from 1975 to 1978.

Nigh (1985) reports a weak positive correlation for the less developed economies and a weak negative correlation for the developed countries. Ancharaz (2003) finds a positive effect with lagged growth for the full sample and for the non-Sub-Saharan African countries, but an insignificant effect for the Sub-Saharan Africa sample. Gastanaga et al. (1998) and Schneider and Frey (1985) found positive significant effects of growth on FDI.

Tax Incentives

The literature remains fairly indecisive regarding whether FDI may be sensitive to tax incentives. Some studies have shown that host country corporate taxes have a significant negative effect on FDI flows. Others have reported that taxes do not have a significant effect on FDI. It is argued that high levels of taxation would discourage foreign direct investment whilst low level of taxes would encourage foreign investors. The latter do consider the nature of tax law in host countries before any investment decisions. Therefore countries try to provide lower tax rate to attract more FDI. However, Narula and Dunning (2000) suggests that tax rates may not be the deciding factor in MNC’s Investment decisions and that other location specific advantages may have a much greater effect.

Hartman (1994), Grubert and Mutti (1991), Hines and Rice (1994), Loree and Guisinger (1995), Cassou (1997) and Kemsley (1998) find that host country corporate income taxes have a significant negative effect on attracting FDI flows. However, Root and Ahmed (1979), Lim (1983), Wheeler and Mody (1992), Jackson and Markowski (1995), Yulin and Reed (1995) and Porcano and Price (1996) conclude that taxes do not have a significant effect on FDI. Swenson (1994) reports a positive correlation.

A variable may affect FDI both positively and negatively. For example, factors, such as labour costs, trade barriers, trade balance, exchange rate and tax have been found to have both negative and positive effects on FDI.

Exchange Rate Valuation

Exchange rate is the value of one currency for the purpose of conversion to another. Exchange rate can affect foreign direct investment in two ways; it can lower the costs of production by MNC and thus affect the competitiveness of goods produced and yield higher profits from foreign firms. Lim (2001) argues that the depreciation of a currency (increase in the exchange rate) could imply that foreign firms would be able to purchase assets and technology in the host country cheaply thus increasing FDI. On the contrary, a decrease in the exchange rate, meaning an appreciation, would imply more foreign currency earnings for the foreign investors hence would increase FDI inflow.

Froot and Stein (1991) find evidence of the relationship: a weaker host country currency tends to increase inward FDI within an imperfect capital market model as depreciation makes host country assets less expensive relative to assets in the home country. Blonigen (1997) makes a "firm-specific asset" argument to show that exchange rate depreciation in host countries tend to increase FDI inflows. But on the other hand, a stronger real exchange rate might be expected to strengthen the incentive of foreign companies to produce domestically: the exchange rate is in a sense a barrier to entry in the market that could lead to more horizontal FDI.

Empirical Evidence:

Two notable studies by Moolman et al (2006) and Fedderke and Romm (2004) focused on determinants of inward FDI to South Africa. Moolman et al (2006) examined the macroeconomic link between FDI in South Africa and its resultant impact on output for the period 1970-2003.They identified supply side determinants of FDI before analysing their impact on output. Results from Moolman et al (2006) study indicates that market size, openness, infrastructure and the nominal exchange rate are factors which South African policy makers should focus on when seeking to attract FDI.

Factors such as increased employment, improved skills and new management techniques were considered (Moolman et al 2006:29). However, only market size and openness were found to be the factors determining FDI. According to another study, Loots and Ahmed et al (2005) found that exchange rate is considered as an important element in determining foreign direct investment in several countries.

Onyeiwu and Shrestha (2004) argue that despite economic and institutional reform in Africa during the past decade, the flow of FDI continues to be disappointing and uneven. In their study, they use the fixed and random effects models to explore whether the stylized determinants of FDI, affect FDI flows to Africa. A panel dataset for 29 African countries were studied over the period 1975 to 1999. Economic growth, inflation, openness of the economy, international reserves and natural resource availability determined FDI flows in Africa. However conventional wisdom, political rights and infrastructures were found to be unimportant for FDI flows to Africa.

Asiedu (2002) analysed the factors determined Foreign Direct Investment in Sub Saharan Africa countries. A cross sectional data of 71 developing countries of which 32 were SSA and 39 non -SSA countries. Ordinary least squares method was used and six widely used variables were considered. Asiedu (2002:110) used return on investment in the host country (inverse of real GDP per capita as proxy), infrastructure development, openness, political risk and other economic variables such as financial depth and government size.

Aseidu found that a higher return on investment and better infrastructure had a positive impact on FDI to non-SSA countries. Openness to trade promotes FDI to non-SSA but however due to geographical location SSA received less FDI. Economic variables such as financial depth, government size and economic stability show that economic variables and the measure of political risk are not significant.

An Obwona (2001) investigated the FDI-growth linkage for Uganda. Obwona used the investor surveys approach and econometric tests. Using investor surveys, both local and foreign investors were directly questioned regarding their decisions and decision-making processes when investing in Uganda (Obwona, 2001). The focus of the study was mainly on productive investment and econometric tests were performed to estimate the determinants of FDI and growth. Time Series data was used for the period 1975-1991.From the survey, the author found out that increased foreign direct investment was a result of favourable investment by government through policies and institutions. Obwona concluded that foreign investors are mostly concerned with fundamental factors such as macroeconomic policy reforms and political situation.

Obwona agreed with other researches such as Nunnekamp (2002) that shifts in the type of investment and the availability of low cost unskilled labour in location decisions has declined over time. More emphasis is being placed on skilled labour or trained workers.

Nunnekamp (2002) sought to assess whether determinants of FDI have changed with globalisation .He wanted to find out whether traditional determinants are losing importance whilst non-traditional ones are increasingly gaining importance. Two approaches were adopted, namely survey data from European Round Table of Industrialists (ERT 2000) and simple correlation for 28 developing countries.

Several Factors such as location cost differences, qualities of infrastructure, ease of doing business and the availability of skills measured by average years of schooling have become increasingly important as non-traditional determinants of FDI (Nunnekamp 2002:16). The result indicates that traditional market still dominates determinants of FDI distribution but non -traditional determinant such as cost factors and trade openness are less important to globalisation. Availability of skills and the secondary rate enrolment rate is considered important factors that affect FDI in the process of globalisation.

Blomstrom et al. used cross sectional and standard panel regressions to find out if FDI has a positive impact on growth in GDP in developing nations than lower income nation. Mutenyo (2008) study also adopt General Method of Moment (GMM) dynamic panel estimator to obtain the efficiency and consistency estimate of the impact of FDI on economic growth in 32 sub Saharan African countries. Foreign Direct investment was found to have a positive impact in economic growth but however the efficiency level is considered lower than private investment.

Ahmed et al (2005) identify determinants of the level and composition of capital flows in 81 emerging markets using the ordinary least squares (OLS) and general methods of moments (GMM) techniques from 1975 to 2002. Ahmed et al (2005:11) point out that due to the use of a lagged dependent variable, OLS estimates become biased and inconsistent; hence they estimate a dynamic panel model using GMM to provide unbiased and consistent estimates. The external factors or push factors that influence capital inflows are international interest rates and business cycle developments in industrial countries.

Previous Studies Based on Foreign Direct Investment:

Empirical Evidence

Description of Main findings

Asiedu (2004)

In order to realize the employment benefits of FDI, sub-Saharan Africa needs to attract FDI in non-natural resource industries and host countries need to improve their infrastructure and human capital stocks.

Asiedu (2006)

From a study using panel data for 22 African countries, finds that natural resources and a large domestic market are important determinants of FDI, and that macroeconomic policies are also significant.

Frenkel, Funke and Stadtmann

The GDP growth rate and the extent of risk and that market size and distance, risk and economic growth.

Mhlanga (2007)

The determinants of FDI to SADC are studied using project-level data. It is found that market size, colonial ties, and proximity of the investing country are the major determinants of FDI to SADC.

Seetanah and Khadaroo(2007)

Investigate the relationship between FDI and growth in the case of 39 African countries over the period 1980–2000. They find that FDI has a positive and significant effect on growth. However, the contribution of FDI to growth is less than that of domestic private and public investment, and also less than in non-African countries.

Batten and Vinh Vo (2008)

A panel data modelling technique to determine the link between FDI and economic growth, and to determine if the relationship changes under educational, institution and economic condition. The outcome of their research was in favour of FDI. Their findings analyse that FDI has a stronger positive role in economic growth in nations with better education achievement, exposure to international trade, sound stock market, low population growth and low level of risk Batten and Vinh Vo (2008).

SADC OVERVIEW:

One of the most important trading blocs in South Africa consist of SADC and COMESA.SADC consists of nine member states, Angola, Botswana, the Democratic Republic of Congo, Lesotho, Madagascar, Malawi, Mauritius, Mozambique, Namibia, South Africa, Swaziland, United Republic of Tanzania, Zambia and Zimbabwe. SADC has been in existence since the 1980 and its main aims consist of coordinating development projects in order to lessen the economic dependence.

The Southern African Development Community (SADC) is seeking to attract more foreign direct investment. However its share on global FDI flows is very minor. SADC tries to achieve development, peace and security and economic growth, to alleviate poverty, enhance the standard and quality of life and also support the disadvantaged through regional integration. Eleven of the 13 SADC member states have joined the FTA. The SADC Trade protocol, which is based on negotiations and offers by contracting parties, aims for liberalization of all trade in 2012. The SADC trade protocol was signed in 1996 by all member states and it provides for the creation of a free trade zone among the member states. The main aim of the protocol is to contribute towards the improvement of the climate for domestic, cross-border and foreign investment.

South Africa is the best performing member in terms of attracting FDI flows. Concerning SADC, most of its inflows is predominantly resource seeking such as Angola and Democratic Republic of Congo. In particular, a 1-percentage increase in FDI leads to 0,048 per cent increase in total employment in SADC. While a 1-percentage increase in trade openness leads to 13, 4 per cent increase in total employment. These findings suggest that trade openness plays a more important role in creating employment in the SADC region than FDI. The latest figures of FDI into SADC by UNCTAD (2001) reveal that the highest amount of FDI inflow in absolute terms was recorded by Angola (US$ 1,8 billion), followed by South Africa with an inflow of US$ 877 million

FDI inflows into the SADC region increased from US$ 54 billion in 2010 to US$ 63 billion in 2011.In Namibia, this increase was attributed to profit reinvestment from mining and capital inflows to other secondary activities. This capital flows are originated in holding companies loans to domestic affiliates to finance capital formation.

C:\Users\Hemraze\Desktop\ChartPic_000876.png

Measure: US $ at current prices and current exchange rate in millions, FDI inwards

C:\Users\Hemraze\Desktop\ChartPic_000884.pngMeasure: US $ at current prices and current exchange rate in millions, FDI outwards

Chapter 2: METHODOLOGY

The focus of the study is to investigate the determinants of foreign direct investment in the Southern African Foreign Development Community. FDI is an important variable in the development process of any country and is regarded as an important determinant. Other factors influencing FDI will be taken into consideration as control variables. This model has been extensively used in the literature (Wheeler and Mody, 1992; Asiedu, 2002, 2006; Quazi, 2005) and has generally included various determinants of FDI such as market size, economic openness, human capital, tax incentives, and political stability among others. The following economic model guided by the empirical literature and based on data availability is formulated:

FDI= f (SIZE; WAGE; XMGDP; SER; TAX,INF )

The rationale and measurement of these variables is briefly explained.

Market Size: implies the initial size of the host country and is an important element for attracting foreign direct investment. Scaperlanda and Mauer (1969) argued that FDI responds positively to market size "once it reaches a threshold level that is large enough to allow economies of scale and efficient utilization of resources". Market size is measured by using real GDP per capita. A higher growth rate will imply that more potential FDI will be attracted to a growing economy as it offers better opportunities to make higher returns. Tsikata et al. (2000)

Wage: A high wage rate for labour intensive production is less expected to attract FDI compared to a low wage rate. Nominal wage rate will be used to determine the labour cost.

SER: It is a measure of human capital as foreign direct investors are also concerned with the quality of the labour force in addition to its cost. Lower wages might imply lowly skilled labour force and this might lead more time to adapt to new technology. Root and Ahmed (1979), Schneider and Frey (1985), Borensztein et al, (1998), Noorbakhsh et al. (2001) and Aseidu (2002) found that the level of human capital is a significant determinant of the locational advantage of a host country and plays a key role in attracting FDI.A higher level of human capital means availability of skilled workers and higher productivity level. Secondary enrolment rate is used to determine the level of labour quality.

Tax Rate: High tax rate will deter the level of FDI in a country compared to a low level of tax rate. Tax rate is measure by the use of corporate tax rate.

Trade Openness: Openness is a measure of trade volume of the host economy that is measured a percentage of the sum of exports and imports to GDP. Trade/GDP (XMGDP) in the regression to examine the impact of openness on FDI. The impact of openness on FDI can have a positive sign if FDI is export-oriented and a negative one if FDI is "tariff jumping".(Asiedu 2002)

The dependent variable, FDI, is measured as the net FDI inflow as a percentage of GDP and is a widely used measure (Asiedu, 2002; Quazi, 2005; Goodspeed et al., 2006).

Infrastructure development in the host economy is vital for investment decisions. A certain level of infrastructure is expected to cut down transaction costs and boost productivity of investment. Therefore, the higher the level of infrastructure, the more FDI flows will be expected. The number of telephone mainlines and mobile phone subscribers (per 1000 people) is used to proxy the availability of infrastructures and communications facilities in African countries, both regarded by foreign companies as important pre-requisites for their investments (Khadaroo and Seetanah, 2007; Calderon and Serven, 2008).

Campos and Kinoshita (2003) argued that good infrastructure is a necessary condition for foreign investors to operate successfully, regardless the type of foreign direct investment. Availability of main telephone lines are used because they are necessary to facilitate communication between home and host countries.

Variable

Measure

Description

Data Source

FDI

FDI

Net annual FDI as a percentage of GDP

unctadstat.unctad.org

World bank

SIZE

Size of the Market

Nominal GDP

WAGE

Labour cost

Nominal wage rate

XMGDP

Level of openness

The ratio of trade to GDP

SER

Education level

Secondary Enrolment ratio

Tax

Corporate tax rate

Annual corporate tax rate

Augmented Dickey Fuller (ADF) - Unit root tests

An Augmented Dickey-Fuller (ADF) is a test for unit root in a time series sample. For this test the more negative it is, the stronger will be the rejection of the hypothesis.

\Delta y_t = \alpha + \beta t + \gamma y_{t-1} + \delta_1 \Delta y_{t-1} + \cdots + \delta_{p-1} \Delta y_{t-p+1} + \varepsilon_t,

α = constant

β = Coefficient on a time trend

ρ = the lag order of autoregressive process

The initial step in regression analysis using time series data is to perform unit root tests to check the characteristics and behaviour of the data. In this study, to examine the time series properties of the data, the Augmented Dickey Fuller (ADF) and the Phillips Perron (PP) tests are employed.

An issue which arises with the ADF and PP tests is the determination of optimal lag length in the dependent variable. To be able to determine the appropriate lag length is to ensure that there is no serial correlation in the residuals. According to Brooks (2002) using too few lags will not remove all of the autocorrelation and using too many will increase the coefficient standard errors which will have the effect of using up the degrees of freedom from the increase in the number of parameters. To determine lag length, the various information criteria were explored.

OLS Framework

The cross sectional OLS analysis is thereafter calculated using data averaged from 1980-2011. The data include one observation per country and heteroskedasticity consistent standard errors. The basic regression, therefore, takes the form:

EGi = α + ßFDIi + ∞ (Conditioning set)i + εi