Determinants of Foreign Direct Investment in Nigeria (1977-2008) OLADAPO TOLULOPE AJAYI

Table of content
Page No
CHAPTER 1: INTRODUCTION 1
CHAPTER2: LITERATURE REVIEW 8
CHAPTER THREE: THEORETICAL FRAMEWORK AND
RESEARCHMETHODOLOGY 71
CHAPTER FOUR:DATA PRESENTATION &
ANALYSIS OF RESULT 78
CHAPTER FIVE: RECOMMENDATIONS AND
CONCLUSION 86
APPENDIX 91
BIBLIOGRAPHY 97

1
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
A perennial challenge facing all of the world's countries, regardless of their level
of economic development, is achieving financial stability, economic growth, and
higher living standards. There are many different paths that can be taken to
achieve these objectives, and every country's path will be different given the
distinctive nature of national economies and political systems.
Yet, based on experiences throughout the world, several basic principles seem to
underpin greater prosperity. These include investment (particularly foreign direct
investment), the spread of technology, strong institutions, sound macroeconomic
policies, an educated workforce, and the existence of a market economy.
Furthermore, a common denominator which appears to link nearly all high-
growth countries together is their participation in, and integration with, the global
economy
In the wake of the global financial crises, foreign direct investment (FDI) has
been touted as a main supplement of national savings as a means to promoting
economic development. FDI is considered less prone to crisis because direct
investors, typically, have a longer-term perspective when engaging in a host
country. In addition to the risk-sharing properties of FDI, it is widely believed that
FDI provides a stronger stimulus to economic growth in host countries than other
types of capital inflows. The underlying argument is that FDI is more than just

2
capital, as it offers access to internationally available technologies and
management knowhow. (The Economist 2001).
FDI does have some potential negative impacts, the most potent being anti-
competitive and restrictive business practices by foreign affiliates, tax avoidance,
and abusive transfer pricing. Volatile investment flows and related payments may
be deleterious to balance of payments, while some FDI is seen as transferring
polluting activities and technologies, the Niger-Delta region of Nigeria being a
prime example. Moreover, there is often fear that FDI may have excessive
influence on economic affairs, with possible negative effects on industrial
development and national security. The intensity of concerns about these types of
impact is diminishing. FDI being an important aspect of international economic
integration, it is playing a larger role in developing economies. FDI has grown at
rates far greater than those of international trade or output since the late 1980s,
especially among the industrialized countries. Estimates by UNCTAD1
(2002) put
the total stock of FDI capital at 17.5% of global GDP in 2000, more than double
the size in 1990 (8.3%). A direct consequence of the greater presence of foreign-
owned firms is the internationalization of production. Currently, companies that
are under control of foreign investors account for about 11% of global production.
FDI has grown dramatically and is now the largest and most stable source of
private capital for developing countries and economies in transition, accounting
for nearly 50% of all those flows in 2002. The increasing role of FDI in host
countries has been accompanied by a change of attitude, from critical wariness

3
toward multinational corporations to sometimes uncritical enthusiasm about their
role in the development process. The domestic policy framework is crucial in
determining whether the net effects of FDI are positive (UNCTAD, 1999). Thus,
instituting (designing and implementing) a policy mix that maximizes the
potential benefits and minimizes the potential negative effects is very important.
Empirical evidence suggests that some countries have been more successful in
this respect than others (UNCTAD, 1999).
Countries typically act both as host to FDI projects in their own country and as
participants in investment projects in other countries. A country’s inward FDI
position is made up of the hosted FDI projects, while the outward FDI position
consists of the FDI projects owned abroad. Both larger inward and outward FDI
positions may make the domestic economy more sensitive to economic
disturbances abroad in the short run.
1.2 STATEMENT OF THE PROBLEM
Growth in neoclassical theory is brought about by increases in the quantity of
factors of production and in the efficiency of their allocation. In a simple world of
two factors, labour and capital, it is often presumed that low-income countries
have abundant labour but less capital. This situation arises owing to shortage of
domestic savings in these countries, which places constraint on capital formation
and hence growth. Even where domestic inputs in addition to labour, are readily
available and hence no problem of input supply, increased production may be
limited by scarcity of imported inputs (hence the need for capital) upon which

4
production processes in low-income countries are based. Foreign direct
investment readily becomes an important means of helping developing countries
to overcome their capital shortage problem. While FDI inflows have been
increasing in some developing countries, Nigeria has not been successful except
in natural-resource exploitation. Given the importance of FDI to Nigeria as a
strategic source of investment capital, an important question that arises is; how
can Nigeria attract FDI into non-extractive sectors of the economy?
1.3 OBJECTIVES OF THE STUDY
The main purpose of this paper is to provide an assessment of empirical evidence
on the determinants of foreign direct investment in Nigeria. In particular, the
following objectives will be examined:
• To assess the determinants of FDI in Africa, especially Nigeria.
• To evaluate the benefits of FDI on the African economy, especially
Nigeria.
• To recommend suitable policies that will maximize the benefits of FDI in
Nigeria.
1.4 RESEARCH QUESTIONS
The study seeks to provide answers to the following questions:
• What are the determinants of FDI in Nigeria?
• What is the Impact of these determinants on FDI in Nigeria?
• What policies will help enhance the growth of FDI in Nigeria?

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1.5 RESEARCH METHODOLOGY
All data to be analyzed will be gotten from secondary sources. The approach to
be used for this study in answering the research questions and testing the
hypothesis will be descriptive analysis and econometric techniques. Descriptive
Analytical tools such as trend graphs would be used in analyzing the trends of
FDI inflows and econometric techniques would be used in analyzing the factors
that cause FDI to accrue to Nigeria through the Ordinary Least Square (OLS)
regression technique.
1.6 RESEARCH HYPOTHESIS:
In achieving the above stated objective the following hypothesis would be tested:
HYPOTHESIS 1
H1
(0); Market growth does not determine FDI in Nigeria.
H1
(1); Market growth is a significant determinant of FDI in Nigeria.
HYPOTHESIS 2
H2
(0); trade-openness does not determine FDI in Nigeria.
H2
(1); trade-openness is a significant determinant of FDI in Nigeria.
HYPOTHESIS 3
H3
(0): Macroeconomic stability does not determine FDI in Nigeria.

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H3
(1): Macroeconomic stability is a significant determinant of FDI in
Nigeria.
HYPOTHESIS 4
H4
(0): Infrastructure development does not determine FDI in Nigeria.
H4
(1): Infrastructure development is a significant determinant of FDI in
Nigeria.
1.7 MODEL SPECIFICATION
FDI = f (market growth, trade-openness, macroeconomic instability, infra dev)
• Where market growth is proxied by Nominal GDP
• Trade openness is proxied by ratio of imports+exports over GDP
• Macroeconomic Instability is proxied by exchange rates and
• Infrastructure development is proxied by Electricity consumption
Therefore LogFDI = f (LogNGDP, EXR, TOPN, ELCON)
Where:
LogFDI = Natural Log of Foreign Direct Investment, the dependent variable,
LogNGDP = Natural Log of Nominal GDP
EXR= Exchange rate
TOPN= trade openness

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ELCON = Electricity Consumption.
In equation form:
LnFDIit
= β0
+ β1
LnNGDPit
+ β2
TOPNit
+ β3
EXRit
+β4
ELCON it
+ ε it
1.8 SIGNIFICANCE OF THE STUDY
FDI has been touted as a cure-all for ailing developing economies. Its impact
analysts say, will reverse the trend of poverty, unemployment and under-
development that is pervasive and persistent in developing economies like
Nigeria’s, but not without potential risks. The recent past global financial
crises highlighted the dangers of increasing interdependence of global
economies; therefore this study is important for research purposes for three
reasons: Understanding the peculiarities of the
Nigerian economy as it concerns Foreign Direct Investment, Creating an
enabling environment which maximises its benefits and help determine
primary areas of focus in order to efficiently allocate scarce resource.

8
LITERATURE REVIEW
2.1 INTRODUCTION
Foreign Direct Investment has long been a subject of interest. This interest has
been renewed in recent years due to strong expansion of world FDI flows
recorded since the 1980’s, an expansion that has made FDI even more important
than trade as a vehicle for international economic integration. Given this fact, it
should come as no surprise that a large number of theoretical explanations as to
the very existence of have been advanced over the years, with many studies
focusing on the investigation of the determinants of such investment. However,
despite the abundance of research, there is at present no universally accepted
model of FDI, as there is still some confusion over what are the key factors
capable of explaining a country’s propensity to attract investment by
Multinational Corporations (MNCs). These unresolved issues are of special
importance to developing countries that now more than ever seek to attract FDI to
fuel economic growth.
Foreign direct investment combines aspects of both international trade in goods
and international financial flows, but is a phenomenon much more complex than
either of these. An essential concept that helps to understand the topic of
discussion is globalization, which is best comprehended in economic and
financial terms. Globalisation may be defined as the broadening and deepening
linkages of national economies into a worldwide market for goods, services and
capital. Perhaps the most prominent face of globalization is the rapid integration
of production and financial markets over the last decade; that is, trade and

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investment as the core driving forces behind globalization. Foreign direct
investment (FDI) has been one of the core features of globalization and the world
economy over the past two decades. More firms in more industries from more
countries are expanding abroad through direct investment than ever before, and
virtually all economies now compete to attract multinational corporations
(MNCs). The past two decades have witnessed an unparalleled opening and
modernization of economies in all regions, encompassing deregulation, removal
of monopolies and privatization and private participation in the provision of
infrastructure, and the reduction and simplification of tariffs. An integral part of
this process has been the liberalization of foreign investment regimes. Indeed, the
wish to attract FDI has been one of the driving forces behind the whole reform
process. Although the pace and scale of reform have varied depending on the
particular circumstances in each country, the direction of change has not. For
developing economies like Nigeria’s FDI is sought as a principal means of capital
augmentation especially since remittances and other development assistance have
declined drastically since the recent global financial crises. FDI can play a key
role in improving the capacity of the host country to respond to the opportunities
offered by global economic integration, a goal increasingly recognized as one of
the key aims of any development strategy.
2.1.2 FDI (DEFINITION)
FDI is an investment made abroad either by establishing a new production facility
or by acquiring a minimum share of an already existing company (Bannock et al,
1998; Ethie, 1995; Lawler and Seddighi, 2001). Unlike foreign bank lending

10
(FBL) and foreign portfolio investment (FPI), FDI is characterized by “the
existence of a long-term relationship between the direct investor and the
enterprise and a significant degree of influence by the direct investor on the
management of the enterprise” (IMF, 1993). A direct investor may be an
individual, a firm, a multinational company (MNC), a financial institution, or a
government. FDI is the essence of MNCs–they are so called because part of their
production is made abroad. Furthermore, MNCs are the major source of FDI –
they generate about ninety-five percent of world FDI flows. When the setting-up
of a new site abroad is financed out of capital raised in the direct investor’s
country, FDI is referred to as greenfield investment (Lawler and Seddighi,
2001). The use of the term greenfield FDI has been extended to cover any
investment made abroad by establishing new productive assets. It does not matter
whether there has been a transfer of capital from the investor’s country (home or
source country) to the host country. Another type of FDI is cross-border or
international merger and acquisitions (M&A). A cross-border M&A is the
transfer of the ownership of a local productive activity and assets from a domestic
to a foreign entity (United Nations, 1998). In the short-term, a country may
benefit more from a greenfield FDI than from a M&A FDI. One of the reasons is
that greenfield FDI impacts directly, immediately and positively on employment
and capital stock. The installation of a new industry in a foreign country adds to
this latter existing capital stock and entails jobs creation. These short-run effects
may not be evident so far as M&A FDIs are concerned. The immediate effects on
factors of production are not the only criteria taken into consideration in

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contrasting the benefits and costs from greenfield and M&A FDI, from a recipient
country point of view. Profits not repatriated by direct investors but kept in a host
country to finance future ventures constitute a type of FDI called reinvested
earnings (Kenwood and Lougheed,1999). It often happens that a foreign affiliate
of a MNC undertakes direct investment abroad. Such a FDI is called indirect FDI
because it represents “an indirect flow of FDI from the parent firm’s home
country (and a direct flow of FDI from the country in which the affiliate is
located)” (United Nations, 1998). Non-success in the activities of a foreign
affiliate, unfavorable changes in the recipient country’s FDI policy, strategic
reasons, and other factors lead MNCs to divestment –withdrawal of an affiliate
from a foreign country.
2.1.3 COMPILATION OF FDI FLOWS
The available statistics on flows of FDI between a country and the rest of the
world are classified into two main categories: FDI inflows (or FDI inward flows)
and FDI outflows (or FDI outward flows). A country’s gross FDI inflows at the
end of a given period are the total amount of direct investments this latter has
received from nonresident investors during this period of time (Investments made
in a host country by an affiliate out of funds borrowed locally are not recorded in
the FDI statistics). On the other hand, a country’s gross FDI outflows are the
value of all greenfield and M&A FDIs made abroad by its residents during a
given period of time. As one can see, aggregate FDI flows are based on the
concept of residence and not on the one of nationality. A direct investment made
in Lagos, Nigeria by a Nigerian resident in the U.K. for the last three years is

12
regarded as FDI outflow from the U.K. to Nigeria even though the investor is a
Nigerian. An FDI by a South-African firm through its affiliate in Ghana, (indirect
FDI) is not considered as an FDI outflow from South-Africa to Nigeria, but as
from Ghana to Nigeria. According to the IMF (1993) guidelines, an investment
abroad should be recorded by the home country as an outward flow of FDI and by
the recipient country as an inward flow of FDI provided the foreign investor owns
at least 10 percent of the ordinary shares or voting power of the direct investment
enterprise. Divestments by foreign investors from a country are deducted from
this host country’s gross FDI inflows and from the foreign investors’ countries’
gross FDI outflows. Net FDI inflows (in home country) are therefore equal to
gross FDI outflows (in foreign country) minus divestments by foreign Investors
(in home country), and net FDI outflows (in home country) equal gross FDI
outflows (in home country) minus divestments from abroad. The value of all the
productive assets held by the non-residents of a country make up what is called
FDI inward stock. FDI outward stock is the net value of all the productive assets
held abroad by the residents of a country. In practice, the compilation of FDI data
is not as simple as presented herein. Governments especially in less developed
countries (LDCs) face difficulties in collecting FDI data because they do not have
“adequate statistics gathering machinery” (South Centre, 1997). Furthermore,
some countries have accounting conventions different from the IMF (1993)
guidelines. These facts explain the discrepancies between world FDI inflows and
world FDI outflows which normally should be equal. Countries’ balances of
payments contain statistics on FDI flows.

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2.1.4 CLASSIFICATION OF CAPITAL FLOWS
In order to augment and shore-up capital, several options exist to a wanting
economy. Capital flows can be divided between public and private flows. Public
flows consist of official development assistance and aid. Official development
assistance and net official aid record the actual international transfer by the donor
of financial resources or of goods or services valued at the cost to the donor, less
any repayments of loan principal during the same period. Public flows are derived
from two principal sources
• bilateral sources e.g. (developed countries and OPEC) and,
• multilateral sources e.g. (such as the World Bank and its two affiliates: the
international development Association (IDA), and the International
Finance Corporation (IFC), on concessional and non-concessional terms
Private capital flows (also known jointly as foreign private investment) consist of
private debt and non-debt flows. Private debt flows include commercial bank
lending, bonds, and other private credits; non-debt private flows are foreign direct
investment and portfolio equity investment.
Private capital flows can be divided into three broad categories:
• Foreign direct investment,
• Foreign portfolio investment, (bonds and equity), and
• Bank and trade related lending.

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2.2 EMPIRICAL LITERATURE
There does not yet appear to be consensus on all the important determinants of
FDI in the empirical literature. In part, this is because there are different types of
FDI, which are affected by different factors. The empirical work on FDI
determinants generally comes in two forms: investor surveys and econometric or
in-depth case studies. Regarding the determinants of FDIs, it must be stated that
there are substantial differences between the flows that only involve developing
countries, whether between home and host countries, and those in which the host
countries are developing countries. According to Dunning (2002), in the former
case strategic asset-seeking investments take place, in which FDI is used in
mergers and acquisitions, seeking horizontal efficiency. In the second case,
investments are characterized by the search for markets, and resources, thus being
of vertical efficiency.
We review two large investor surveys first. The first is a recent survey of CEOs,
CFOs, and other top corporate executives of the Global 1000 companies by A.T.
Kearney, a global management consulting firm. The survey cites large market
size, political and macroeconomic stability, GDP growth, regulatory environment,
and the ability to repatriate profits as the five most important factors affecting FDI
(Development Business, 1999).
In 1994, the World Bank conducted a survey of 173 Japanese manufacturing
investors on their likelihood of investing in an East Asian country over the
coming three years, on a scale of 1 to 7, with 7 being very likely (Kawaguchi,
1994). Against this subjective probability, the participants were also asked to rank

15
various characteristics of the countries, on a numerical scale of 1 to 10, with 10
being very favorable. Using pooled regressions, the Bank found that the most
important determinants were the size of the market; the cost of labor; and FDI
policies. On the last, the investors viewed restrictions on repatriation of earnings,
local content and local ownership requirements as serious disincentives to FDI.
Surveys of investors have indicated that political and macroeconomic stability is
one of the key concerns of potential foreign investors. However, empirical results
are somewhat mixed. Wheeler and Mody (1992) find that political risk and
administrative efficiency are insignificant in determining the production location
decisions of U.S. firms. On the other hand, Root and Ahmed (1979), looking at
aggregate investment flows into developing economies in the late 1960s, and
Schneider and Frey (1985), using a similar sample for a slightly later time period,
find that political instability significantly affects FDI inflows.
Nunnenkamp and Spatz (2002), studying a sample of 28 developing countries
during the 1987-2000 period, find significant Spearman correlations between FDI
flows and per capita GNP, risk factors, years of schooling, foreign trade
restrictions, complementary production factors, administrative bottlenecks and
cost factors. Population, GNP growth, firm entry restrictions, post-entry
restrictions, and technology regulation all proved to be non-significant. However,
when regressions were performed separately for the non-traditional factors, in
which traditional factors were controls (population and per capita GNP), only

16
factor costs produced significant results and, even so, only for the 1997-2000
period.
Garibaldi and others (2001), based on a dynamic panel of 26 transition economies
between 1990 and 1999, analysed a large set of variables that were divided into
macroeconomic factors, structural reforms, institutional and legal frameworks,
initial conditions, and risk analyses. The results indicated that macroeconomic
variables, such as market size, fiscal deficit, inflation and exchange regime, risk
analysis, economic reforms, trade openness, availability of natural resources,
barriers to investment and bureaucracy all had the expected signs and were
significant.
Mottaleb (2007) on a study on developing countries employed OLS estimation
technique and the results showed that countries with large market, large market
potentials and relatively higher contribution of industries to GDP are more likely
to contribute to FDI. There was also a positive relation between internet
availability and FDI. While the coefficient of telephone mainline users, time
required to enforce a contract, time required to start a business, corruption
perception index and merchandise trade were not significant.
In recent years, a flurry of studies has emerged, seeking explanations for why sub-
Saharan Africa has been relatively unsuccessful in attracting FDI (Bhattacharaya
et al., 1996; Collier Asiedu, 2002, 2004). In spite of methodological differences,
the broad conclusions are largely the same. The macroeconomic policy
environment is an important determinant of investment; and trade restrictions,
inadequate transport and telecommunications links, low productivity, and

17
corruption make Africa unattractive to potential investors. Asiedu (2002), for
example, used a cross country regression model comprising 71 developing
countries, half of which are in Africa. She found that FDI is uniformly low in
Africa and a country in Africa will receive less FDI by virtue of its geographical
location. She observed that policies that have been successful in other regions
may not be equally successful in Africa. A higher return on investment and better
infrastructure have a positive impact on FDI to non-SSA countries, but have no
significant impact on FDI to SSA. Openness to trade promotes FDI to SSA and
non-SSA countries, but the marginal benefit from increased openness is less for
SSA. In a complementary study, Asiedu (2004) contends that although SSA has
reformed its institutions, improved its infrastructure and liberalized its FDI
regulatory framework, the degree of reform was mediocre compared with the
reform implemented in other developing countries. As a consequence, relative to
other regions, SSA has become less attractive for FDI. Jenkins and Thomas
(2002) also recognize that Africa is significantly different; they ascribe the lower
geographical spread to an African perspective that instability is endemic.
Collier and Patillo (1999) argue that investment is low in Africa because of the
closed trade policy, inadequate transport and telecommunications, low
productivity and corruption. Cantwell (1997) has suggested that most African
countries lack the skill and technological infrastructure to effectively absorb
larger flows of FDI even in the primary sector and Lall (2004) sees the lack of
“technological effort” in Africa as cutting it off from the most dynamic
components of global FDI flows in manufacturing.

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Onyeiwu and Shrestha (2004) argue that despite economic and institutional
reform in Africa during the past decade, the flow of Foreign Direct Investment
(FDI) to the region 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 in conventional ways.
Based on a panel dataset for 29 African countries over the period 1975 to 1999,
their paper identifies the following factors as significant for FDI flows to Africa:
economic growth, inflation, openness of the economy, international reserves, and
natural resource availability. Contrary to conventional wisdom, political rights and
infrastructures were found to be unimportant for FDI flows to Africa. The
significance of a variable for FDI flows to Africa was found to be dependent on
whether country- and time-specific effects are fixed or stochastic.
The low level of FDI to Africa is also explained by the reversible nature of
liberalization efforts and the abuse of trade policies for wider economic and
social goals. Others have singled out unfavourable and unstable tax regimes
(Gastanaga et al. 1998), large external debt burdens (Sachs 2004), the slow
pace of public sector reform, particularly privatization (Akingube 2003) and
the inadequacy of intellectual property protection as erecting serious obstacles
to FDI in Africa.
However, Lyakurwa (2003) has stressed macroeconomic policy failures as
deflecting FDI flows from Africa. According to Lyakurwa, irresponsible fiscal
and monetary policies have generated unsustainable budget deficits and

19
inflationary pressures, raising local production costs, generating exchange rate
instability and making the region too risky a location for FDI. In addition,
excessive levels of corruption, regulation and political risk are also believed to
have further raised costs, adding to an unattractive business climate for FDI.
Using least squares technique on annual data for 1962 – 1974 Obadan (1982)
supports the market size hypothesis confirming the role of protectionist
policies (tariff barriers). The study suggests factors such as market size, growth
and tariff policy when dealing with policy issues relating to foreign investment
to the country. In Nigeria, Ekpo (1997) examined the relationship(s) between
FDI and some macroeconomic variables for the period 1970-1994. The
author’s results showed that the political regime, real income per capita, rate of
inflation, world interest rate, credit rating, and debt service explained the
variance of FDI inflows to Nigeria.
Anyanwu’s (1998) study of the economic determinants of FDI in Nigeria also
confirmed the positive role of domestic market size in determining FDI inflow
into the country. This study noted that the abrogation of the indigenization policy
in 1995 significantly encouraged the flow of FDI into the country and that more
effort is required in raising the nation’s economic growth so as to attract more
FDI. Iyoha (2001) examined the effects of macroeconomic instability and
uncertainty, economic size and external debt on foreign private investment
inflows. He shows that market size attracts FDI to Nigeria whereas inflation

20
discourages it. The study confirms that unsuitable macroeconomic policy acts to
discourage foreign investment inflows into the country.
Adaora Nwakwo (2006) at the 6th
global conference on business and
economics identifies market-size, macroeconomic stability, political stability
and the availability of natural resources as statistically significant in
encouraging foreign investment in Nigeria while political instability
discourages foreign investment for the period 1965 to 2003.
Dinda (2009) following a symmetric time series approach examined the
determinants of FDI flow to Nigeria. The results showed that natural resource is
an important determinant of FDI inflow in Nigeria. Hence, the bulk of FDI in
Nigeria can be explained by resource-seeking FDI. Also, macroeconomic factors
like inflation rate, foreign exchange rate and government policies like openness
were the crucial determining factors of FDI flows to Nigeria during the period
1970-2006. The study established that as opposed to most studies for other
countries that market size is not a major determining factor in Nigeria.
Abu and Nurudeen (2010), using time series data from 1979 to 2006, concluded
that that the principal determinants of FDI in Nigeria are the market size of the
host country, deregulation, exchange rate depreciation and political instability,
while variables such as trade-openness and inflation and infrastructure where
statistically insignificant in their model.
In conclusion, recent evidence suggests that foreign direct investment tends to go
to countries with good governance, if one holds constant the size of the country,

21
labor cost, tax rate, laws and incentives specifically related to foreign-invested
firms and other factors. Moreover, the quantitative effect of bad governance on
FDI is quite large.
2.3 FDI THEORIES
The recurring question which the theories of FDI seek to answer is simple; why
would a firm choose to service a foreign market through affiliate production,
rather than other options such as exporting or licensing arrangements?
In broad terms, classical theorists advance the claim that FDI and multinational
corporations (MNCs) contribute to the economic development of host countries
through a number of channels. These include the transfer of capital, advanced
technological equipment and skills (Gao 2005; Mody 2004; Asheghian 2004), the
improvement in the balance of payments, the expansion of the tax base and
foreign exchange earnings, the creation of employment, infrastructural
development and the integration of the host economy into international markets
(Li and Liu 2005). These claims about FDI have been amplified by the
phenomenal economic growth of the newly industrialized countries, Hong Kong,
Taiwan, Singapore and South Korea, especially in the 1980s and early 1990s
(Muchlinski 1995; Ulmer 1980) and more recently by China's impressive
economic growth (Cheung and Lin 2004; UCTAD 2003; World Bank 2003).
Although the first theoretical studies of the determinants of FDI go back to Adam
Smith, Stuart Mill and Torrens, one of the first to address the issue was Ohlin
(1933). According to him, foreign direct investment was motivated mainly by the

22
possibility of high profitability in growing markets, along with the possibility of
financing these investments at relatively low rates of interest in the host country.
Other determinants were the necessity to overcome trade barriers and to secure
sources of raw materials. This is also known as the capital market theory. This
idea was prevalent until the 1960s, as FDI was largely assumed to exist as a result
of international differences in rates of return on capital investment, with capital
moving across countries in search of higher rates of return. Although the
hypothesis appeared to be consistent with the pattern of FDI flows recorded in the
1950s (when many US MNCs obtained higher returns from their European
investments), its explanatory power declined a decade later when US investment
in Europe continued to rise in spite of higher rates of return registered for US
domestic investment (Hufbauer, 1975). The implicit assumption of a single rate of
return across industries, and the implication that bilateral FDI flows between two
countries could not occur, also made the hypothesis theoretically unconvincing.
This theory was further extended to the application of Markowitz and
Tobin’s portfolio diversification theory. This approach contends that in making
investment decisions MNCs consider not only the rate of return but also the risk
involved. Since the returns to be earned in different foreign markets are unlikely
to be correlated, the international diversification of a MNCs investment
portfolio would reduce the overall risk of the investor. Empirical studies have
offered only weak support for this hypothesis. This is not surprising when one
considers the failure of the model to explain the observed differences between
industries’ propensities to invest overseas, and to account for the fact that many

23
MNCs’ investment portfolios tend to be clustered in markets with highly
correlated expected returns.
The industrial organization approach (Hymer, 1960) is based on the idea that
due to structural market imperfections, some firms enjoy advantages vis-à-vis
competitors. Firms constantly seek market opportunities and their decision to
invest overseas is explained as a strategy to capitalize on certain capabilities not
shared by their competitors in foreign countries These advantages (including
brand name/proprietary information, patents, superior technology, organizational
know-how and managerial skills) allow such firms to obtain rents in foreign
markets that more than compensate for the inevitable initial disadvantages (for
example, inferior market knowledge) to be experienced when competing with
local firms within the alien environment, since local firms have superior
knowledge about local conditions). Firms, therefore, invest abroad to capitalize on
such advantages. With these advantages, MNCs would prefer to supply the
foreign market by way of direct investments (in developing countries) instead of
through (direct) exports. In an analogous manner, MNCs would not be willing to
license production to local firms if the local firms were uncertain about the value
of the license or if the know-how transfer costs (property rights) were too high.
Hymer also argued that this conduct by firms, which often results in ‘swallowing
up’ competition affects market structure and allows MNCs to exploit monopoly
and oligopoly powers. Kindleberger (1969) slightly modifies Hymer’s analysis.
Instead of MNC behavior determining the market structure, it is the market

24
structure – monopolistic competition - that will determine the conduct of the firm,
by internalizing its production. Kindleberger argues that market imperfections
lead to FDI, specifically through market disequilibrium, government involvement,
and market failure.
Caves (1971), also develops a similar analysis, in which structure dictates
conduct. FDIs will be made basically in sectors that are dominated by oligopolies,
as a natural response to the characteristics of an oligopoly. This is known as the
oligopolistic reaction theory. If there is product differentiation, horizontal
investments may take place, i.e., in the same sector. If there is no product
differentiation, vertical investments will be made, in sectors that are behind in the
productive chain of firms. The offensive and defensive strategies of firms
operating within imperfect markets have also been examined by Knickerbocker
(1973). He concluded that it is the interdependence, rivalry and uncertainty
inherent in the nature of oligopolies that explains the observed clustering of FDI
in such industries. Higher industrial concentration causes increased oligopolistic
reaction in the form of FDI except at very high levels, where equilibrium is
reached to avoid the overcrowding of the host country market. Also along these
lines we have the studies developed by Graham [(1978), (1998) and (2000)].
According to these studies, the emergence of MNCs is a result of oligopolistic
interaction as firms grow, as a risk reduction strategy. In his most recent study,
the author employs game theory in order to develop a simplified two-country,
one-sector model to analyse the entrance of a firm in a foreign country, and to
study the reaction to the entrance of a firm from another country in the local

25
market. The existence of FDI is further related to trade barriers, as a way of
avoiding uncertainties in supplies, or as a way of imposing barriers to new firms
on the external market.
A second line of studies of the determinants of FDI is based on the idea of
transaction cost internalization. Buckley and Casson (1976) and (1981), and
Buckley (1985) were the first to develop this hypothesis, starting with the idea
that the intermediate product markets are imperfect, having higher transaction
costs, when managed by different firms. Firms aspire to develop their own
internal markets whenever transactions can be made at lower cost within the firm.
Thus, internalization involves a form of vertical integration bringing new
operations and activities, formerly carried out by intermediate markets, under the
ownership and governance of the firm. MNCs have proprietary assets with regard
to marketing, designs, patents, trademarks, innovative capacity, etc., whose
transfer may be costly for being intangible assets, or due to a good sense of
opportunity, or even because they are diffuse, and thus difficult to sell or lease.
The internalization theory emphasizes the intermediary product market and the
formation of international production networks. The theory’s main strength may
lie in its capacity to address the dilemma between the licensing of production to a
foreign agent and own production. Therefore, the firm must make two decisions:
location and mode of control. When production and control are located in the
home country, the firm exports; when production and control take place in the
host country, FDI is made. Normally, these decisions concern the several stages
of product internationalization

26
The product cycle hypothesis (Kuznetz, 1953; Posner, 1961; Vernon, 1966)
postulates that an innovation may emerge as a developed country export, extend
its life cycle by being produced in more favorable foreign locations during its
maturing phase and ultimately, once standardized, become a developing country
export (developed country import). According to this model, since innovations are
labor savers, they initially appear in those countries that are more capital
intensive, especially the US. FDI, therefore, occurs when, as the product matures
and competition becomes fierce, the innovator decides to shift production in
developing countries because lower factor costs make this advantageous. At the
same time, production in richer countries is reoriented towards new products that
incorporate innovations in products and processes. This model was partially
responsible for a set of studies that regarded the spreading of multinational
corporations as being sequential, taking place in stages. The firms would initially
supply the export market, then establish trade representatives abroad, and
eventually end up setting up production in target markets by way of subsidiaries.
This model was primarily intended to explain the expansion of US MNCs in
Europe after the Second World War and, at the time of its inception, could
account for the high concentration of innovations in, and technological superiority
of, the USA. Although during the late 1960s and early 1970s a number of
empirical studies provided results consistent with the hypothesis’ insightful
description of the dynamic process of product development, the model is now
regarded by many as largely anachronistic. First, the technological gap between
the USA and other regions of the world (most notably Europe and Japan) has been

27
eroded. Second, the product life extension which characterizes the maturity phase
is difficult to reconcile with MNCs’ tendency to produce the new product where
factor costs are at their lowest from the start, and opt for a simultaneous
introduction phase of the product worldwide.
Work conducted by a group of Scandinavian researchers at Uppsala University,
however, questioned the explanatory power of the product cycle theory by
emphasizing the limited knowledge of the individual investing firm as the most
significant determinant. This model, known as the internationalization theory
elaborated by Johanson and Wiedersheim-Paul (1975) from the University of
Uppsala (Sweden) states that generally a MNC does not commence its activities
by making gigantic FDIs. It first operates in the domestic market and then
gradually expands its activities abroad. Johanson and Wiedersheim-Paul (1975)
identified a four-stage sequence leading to international production. Firms begin
by serving the domestic market, and then foreign markets are penetrated through
exports. After some time, sales outlets are established abroad until; finally,
foreign production facilities are set up. In contrast to the international trade and
FDI theories, outlined above, internationalization theories endeavor to explain
how and why the firm engages in overseas activities and, in particular, how the
dynamic nature of such behavior can be conceptualized. This research was based
on the experience of Swedish firms.
Dunning reviewed and assessed the main theories advanced to explain the reasons
behind FDI. This model known as Dunning’s eclectic theory attempts to
synthesize all prior theories into a cogent whole. Dunning develops an approach

28
that must be understood, in his view, as a paradigm known as OLI (Ownership,
Location, Internalization). This paradigm may be schematically presented as
follows:
Foreign firms hold advantages over domestic firms in a given sector as a result of
privileged ownership of certain tangible or intangible assets that are only
available to firms, also known as knowledge capital (1). This ownership
advantage may be a product (brand) or process differentiation ability, a monopoly
power, reputation, a better resource capacity or usage, a trademark protected by a
patent, or an exclusive, favored access to product markets Given (1), The second
condition requires that the firm prefer internalizing its ownership advantages
rather than externalizing them. This means that the firm possessing ownership
advantages must deem producing abroad more profitable than selling or leasing
its activities to foreign firms. A firm might prefer internalizing its ownership
advantages in order to protect the quality of its products, to control supplies and
conditions of sales of inputs, to control market outlets(I)(2). This capital can
easily be reproduced in different countries without losing its value, and can easily
be transferred within the firm with low transaction costs. Given (1) and (2), the
foreign firm will decide to produce in the host country if there are sufficient
locational advantages (L) to justify production in that country, and not is any
other such as producing close to final consumers, obtaining cheap inputs, higher
labor productivity, avoiding trade barriers, etc. The extent to which a country‘s
firms possess ownership advantages and internalization incentives, and the
locational attraction of its endowments compared to those of other countries

29
explain its propensity to engage in foreign production. In conclusion, The eclectic,
or OLI paradigm, suggests that the greater the O and I advantages possessed by
firms and the more the L advantages of creating, acquiring (or augmenting) and
exploiting these advantages from a location outside its home country, the more
FDI will be undertaken. Where firms possess substantial O and I advantages but
the L advantages favor the home country, then domestic investment will be
preferred to FDI and foreign markets will be supplies by exports.
The last FDI theory that this paper will review is that by Kojima. According to
Kojima’s theory, there are two types of FDI, macroeconomic and microeconomic.
Macroeconomic FDI responds to change in comparative advantage, whilst
microeconomic FDI does not (Kojima 1982; Kojima and Ozawa 1984).
Macroeconomic FDI according to this theory is that which is undertaken by small
firms in order to facilitate the transfer of production from high wage countries to
low-wage ones. Microeconomic FDI on the other hand is that carried out by large
firms aimed at exploiting oligopolistic advantages in factors as well as product
markets (Gary 1982). Kojima’s theory has been criticized as being grossly
inaccurate and theoretically misleading because his theory rejects the basic
microeconomic determinants of FDI (Arndt 1974). Arndt argues that firms, large
or small, undertake FDI to overcome competition either in their home country or
in a foreign one – an issue synonymous with both macroeconomic and
microeconomic FDI. Other criticisms of Kojima’s theory posit that the
microeconomic determinants of FDI are not an alternative to a macroeconomic

30
theory of FDI. Hence to argue that microeconomic theory fails to explain
macroeconomic phenomena is invalid (Lee 1984).
Other FDI theories worthy of mention include: the Japanese FDI theories, the
diversification theory (Agmond and Lessard), the Appropriability theory (Magee),
e.t.c.
2.3.1 FDI CLASSIFICATION
The literature on FDI identifies at the least four different motives for firms to
invest across
national borders (UNCTAD, 1998). These are:
Market-seeking investment seeks access to new markets that are attractive because
of their size, growth or a combination of both. Market-seeking FDI in services
and other parts of manufacturing can benefit host countries’ consumers by
introducing new products and services, by modernizing local production and
marketing and by increasing the level of competition in the host economies.
However, fiercer competition may also lead to the crowding out of local
competitors, especially if foreign affiliates command superior market power.
Moreover, in the long run, the host countries’ balance of payments is likely to
deteriorate through the repatriation of funds since market-seeking FDI often does
not generate export revenues, especially if the protection of local markets
discriminates against exports. Hence, the growth impact of this type of FDI
should be weaker than the growth impact of efficiency-seeking FDI.
Efficiency-seeking investments aim at taking advantage of cost-efficient
production conditions at a certain location. Important factors that are taken into

31
consideration are the cost and productivity levels of the local workforce, the cost
and quality of infrastructure services (transport, telecommunications), and the
administrative costs of doing business. This motive is predominant in sectors
where products are produced mainly for regional and global markets and
competition is mostly based on price (such as in textiles and garments, electronic
or electrical equipment, etc.) and not on quality differentiation. By contrast,
efficiency-seeking FDI in some parts of manufacturing draws on the relative
factor endowment and the local assets of host economies (UNCTAD, 1998). This
type of FDI is more likely to bring in technology and knowhow that is compatible
to the host countries’ level of development, and to enable local suppliers and
competitors to benefit from spillovers through adaptation and imitation.
Additionally, the world market orientation of efficiency-seeking FDI should
generate foreign-exchange earnings for host economies. As a result, one would
expect a relatively strong
growth impact of FDI in industries that attract efficiency-seeking FDI.
Natural-resource seeking investment seeks to exploit endowments of natural
resources. Naturally, the production and extraction of the resource is bound to the
precise location, but given that most resources can be found in a relatively large
number of locations, companies usually choose locations on the basis of
differences in production costs. These factors are closely linked to the different
motives for FDI in developing economies. For instance, resource-seeking

32
FDI in the primary sector tends to involve a large up-front transfer of capital,
technology and know-how, and to generate high foreign exchange earnings. On
the other hand, resource seeking
FDI is often concentrated in enclaves dominated by foreign affiliates with few
linkages to the local product and labour markets. Furthermore, its macroeconomic
benefits can easily be embezzled or squandered by corrupt local elites. Rather
than enhancing economic growth, resource-seeking FDI in the primary sector
might lead the country into some kind of “Dutch
Disease”.
Strategic-asset seeking investment is oriented towards man-made assets, as
embodied in a highly-qualified and specialized workforce, brand names and
images, shares in particular markets, etc. Increasingly, such FDI takes the form of
cross-border mergers and acquisitions, whereby a foreign firm takes over the
entire or part of a domestic company that is in possession of such assets. In
reality, these motives are seldom isolated from one another. In most cases, FDI is
motivated by a combination of two or more of these factors as shown in table 2.1.

33
Table 2.1
Strategic
objective
Economic
Determinants
Political
Determinants
Other
Determinants
Market-seeking
FDI
Nominal GDP
GDP per capita
GDP growth rate
Previous FDI
Real wage
Production costs
Transport costs
Infrastructure
tariffs
And other Import
restrictions
Ownership policies
Price controls
Convertibility of
foreign exchange
Performance
requirements
Market access
constraints
Sector-specific
control
geographical
location
cultural differences
different languages
population
local content
requirements
country specific
customer
preferences
Efficiency-
seeking FDI
inflation
exchange rate
real wage
savings rate
domestic
investments
production costs
infrastructure
transportation
costs
previous FDI
market access
constraints
ownership
constraints
tax and subsidies
price controls
performance
requirements
FDI incentives
trade agreements
requirements of
environmental
protection
geographical
location
availability of
suitable
workforce
existence of
suppliers
Natural-resource
seeking FDI
price of raw
materials
infrastructure
transportation
costs
domestic
investments
FDI incentives
FDI restrictions
sector-specific
controls
existence and
quality of raw
materials
existence and
protection of
intellectual property existence of

34
strategic-assets
seeking FDI
quality of
infrastructure
intensity of R&D
activities
FDI incentives or
restrictions in host
country resources
risk level,
innovation
patents,
trademarks, etc.
2.4 FDI IN AFRICA
Regional Trends
FDI inflows into Africa rose to $88 billion in 2008 (World Investment Report
2009) another record level, despite the global financial and economic crisis. This
increased the FDI stock in the region to $511 billion. Cross-border M&As, the
value of which more than doubled in 2008, contributed to a large part of the
increased inflows, in spite of global liquidity constraints. The booming global
commodities market the previous year was a major factor in attracting FDI to the
region. The main FDI recipients included many natural-resource producers that
have been attracting large shares of the region’s inflows in the past few years, but
also some additional commodity-rich countries. In 2008, FDI inflows increased in
all sub-regions of Africa, except North Africa. While Southern Africa attracted
almost one third of the inflows, West African countries recorded the largest
percentage increase (63%). Developed countries were the leading sources of FDI
in Africa, although their share in the region’s FDI stock has fallen over time. A
number of African countries adopted policy measures to make the business
environment in the region more conducive to FDI, although the region’s overall
investment climate still offers a mixed picture. For example, some African

35
governments established free economic zones and new investment codes to attract
FDI, and privatized utilities. However, some countries also adopted less
favourable regulations, such as tax increases.
In the early 1970s, Africa absorbed more FDI per unit of GDP than Asia, and not
much less than Latin America, but by the 1980s this had changed dramatically
(UNCTAD, 1995). The volume of FDI that flows to Africa is not only very low
(as a share of total global FDI flows or even as a share of FDI flows to developing
countries), but also the share is on a steady downward trend for three decades.
Africa accounts for just 2 to 3 per cent of global flows, down from a peak of 6 per
cent in the mid-1970s, and less than 9 per cent of developing-country flows
compared to an earlier peak of 28 per cent in 1976 (UNCTAD 2005). In 2006,
FDI inflow to Africa rose by 20% to $36 billion, twice their 2004 level. Following
substantial increases in commodity prices, many MNCs, particularly those from
developed countries already operating in the region, significantly expanded their
activities in oil, gas and mining industries (UNCTAD 2007).
The 24 countries in Africa classified by the World Bank as oil- and mineral-
dependent have on average accounted for close to three-quarters of annual FDI
flows over the past two decades. FDI in Africa has tended to concentrate in a few
countries. In recent years, just three countries (South Africa, Angola, and Nigeria)
accounted for 55 per cent of the total. The top fifth (10 out of 48 countries)
account for 80 per cent, and the bottom half account for less than 5 per cent. This
trend has held for at least the last three decades, with the top 10 countries
accounting for more than 75 per cent of the continent’s total FDI inflows. In Sub

36
Saharan Africa, the preferred FDI destinations were: Angola, Equatorial Guinea,
Nigeria and South Africa. FDI figures for the respective countries are shown in
table 2.2
Important Note
UNCTAD’s Inward FDI Potential Index assesses each country’s
attractiveness for FDI inflows based on eight variables. The eight variables are:
GDP per capita, real GDP growth for the past ten years, exports as a percentage of
GDP, number of telephone lines per 1000 inhabitants, commercial energy use per
capita, R&D expenditures as a percentage of gross national income, students in
tertiary education as a percentage of total population, and political risk. The
mathematical formula is:
Score = Vi - Vmin
Vmax - Vmin
Where; Vi = the value of a variable for country i, Vmin = the lowest value of a
variable among the countries, Vmax = the highest value of a variable among the
countries

37
table 2.2 source oecd database, organization for economic cooperation and development.)
FDI FDI INFLOWS FDI OUTFLOWS FDI
INFLOWS/GFCF*(
%)
YEAR 2006 2007 2008 2006 2007 2008 200
6
200
7
200
8
INWARD
FDI
POTENTI
AL INDEX
(2006)
ANGOL
A
9063.
7
9795.
8
15547
.7
194.2 911.9 2569.
6
161.
3
156.
4
176.
4
76.0
E/GUIN
EA
1655.
8
1726.
5
1289.
6
51.4 4O.
4
20.5
NIGERIA 13956
.5
12453
.7
20278
.5
227.6 468.0 298.6 116.
1
81.1 103.
1
88.0
S/AFRIC
A
-527.1 5687.
2
9009.
2
6067.
2
2962.
1
-
3533.
3
-1.1 9.5 14.0 74.0
FDI 2006-2008 for four select African countries. (All values are in ($)million USD)
*GFCF: Gross Fixed capital Formation.

38
2.4.1 FDI THEORIES IN AFRICA.
Historical Background.
The 1950s, 1960s and 1970s represented a period of uncertainty for foreign
investors in Africa. Many of their assets or investments were either expropriated
or nationalized by host states. MNCs were viewed as inimical to the economic
development of the developing countries. Based on this assertion, MNCs were
either discriminated against or their role in the host economy severely restricted or
limited (Seid 2002). This also provided a justification for the expropriation of
foreign companies or assets. Many MNCs were stripped of their assets by many
developing countries particularly during the early days of their independence
symbolized a rejection by these countries of being externally dependent upon
"foreigners" (Kennnedy 1992). As Kobrin (1984) observes:
The end of the colonial era and the rise of Third World
assertiveness and independence during the late 1960s and early
1970s influenced the preference for expropriation as opposed to
regulatory control of behavior ... There was a tendency on the
part of many countries to use foreign investment as a symbol of
Western industrialization and Western colonialism; expropriation
represented a rejection of the general context as well as of the
specific enterprise.
However, the hostility directed at MNCs in the 1950s and 1970s has largely
waned. Rather than strangle the development of FDI on the basis that it is a source
of foreign domination and control, many countries have now come to recognize
that positive economic gains can be achieved from the presence of FDI (Kobrin

39
2005). This change in attitude can be attributed to, the slowdown of growth in the
world economy in the mid-1970s, change in political leadership and the scarcity
of financial capital in the wake of the debt crisis of the early 1980s (UNCTAD
1999). Since the 1990s, following the disappearance of commercial bank lending
for most countries, FDI has become the largest single source of finance for
developing countries (Aitken and Harrison 1999). Just about every government is
involved in trying to attract more FDI by promulgating laws and regulations that
are investor friendly. Despite, for instance, the likelihood of harmful tax
competition resulting from tax concessions given to MNCs, the 1991 UNCTAD
report reveals that between 1977 and 1987 both developed and developing
countries changed their respective tax subsidy policies in an attempt to entice
MNCs (Kebonang 2001). These changes in tax policy, although wasteful (as they
simply confer a windfall on MNCs), demonstrate clearly the importance countries
now attach to FDI.
The Dependency Theory.
Despite the centrality of FDI to Africa’s Economic growth and development,
enthusiasm about FDI is not widespread. Some commentators such as Bond
(2002) and Tandon (2002) among others have either impliedly or expressly
questioned the need for FDI. Bond (2002) sees for instance, multinational
corporations as agents of 'global apartheid' responsible for Africa's worsening
economic state, whilst Tandon (2002) argues that what Africa needs is 'self-
reliance and not FDI reliance'. The above views, which implicitly suggest that
FDI is exploitative, find sympathy in the dependency theory of FDI. Drawing

40
from the experience of Latin American countries, proponents of this theory argue
that relations of free trade and foreign investment with the industrialized countries
are the main causes of underdevelopment and exploitation of developing
economies (Wilhelms and Witter 1998). This theory focuses largely on the
relationship between the center and periphery. Well-developed and industrialized
countries are deemed to constitute the center and the least developed countries the
periphery. In this regard, FDI is seen as a conduit through which the center
exploits the periphery and perpetuates the latter's state of underdevelopment and
dependence.
Instead of promoting economic development, the argument goes; foreign
investment strangulates such development and perpetuates the domination of the
weaker states by keeping them in a position of permanent and constant
dependence on the economies of the developed states (Sornarajah 1994). MNCs
are accused of being "imperialist predators' that exploit developing countries and
exacerbate their underdevelopment (Alfaro 2003). These views are largely
informed by the fact that multinationals have often been involved in the
exploitation of natural resources with no corresponding benefits for host
economies (UNCTAD 1999). The dependency theory is therefore very much a
reaction against this "extractive nature" of FDI.
Under the dependency theory, FDI is considered to promote dependence and
underdevelopment through its promotion of specialization in production and
exports of primary products; increased reliance by least developed countries
(LDCs) on foreign products and capital intensive technology; diffusion of western

41
values and elite consumption; acute growth inequality in income distribution and
rising unemployment and destruction of indigenous production capacity (Gorg
and Strobl 2002; Girma and Wakelin 2000). The crowding-out or displacement of
indigenous production necessarily eliminates the development of the national
entrepreneurial class and hence "excludes the possibility of self-sustained national
development" (Biersteker 1978). This dependency is also worsened by the
remittance or repatriation of profit, royalties, interest payments, declining
reinvestment and lack of local economic spin-off, which taken together lead to a
'decapitalization' of the host economy (Rojas 2002).
These surplus transfers reduce funds available for domestic investment in the less
developed countries (Rojas 2002). As a result developing countries are compelled
to seek new forms of foreign financing--be it in the form of aid or loans to finance
their development or cover existing deficits, in the process they create a perpetual
state of dependency (Dos Santos 1970). Accordingly to address this problem, the
dependency theorists contend that the solution to underdevelopment requires
closing developing countries to international investment and trade (Wilhelm and
Witter 1998). Because of the perceived exploitative nature of FDI, the
dependency and underdevelopment it engenders, proponents of the dependency
theory are in unison in calling for the adoption of state policies that are
deliberately discriminative of FDI in order to foster the development of local
industries and promote self-reliance. Only by this means, so they contend, can
developing countries or governments acquire the autonomy and freedom to

42
achieve structural changes and economic diversification free from constraints on
their development (Blumenfeld 1991).
Despite its near reverence especially in the 1960s and 70s, the theoretical
dominance of the dependency theory over state policies has become limited. More
countries are now competing for FDI to stimulate economic growth and
development. Governments which were once hostile to foreign investors are now
actively seeking and competing for them. Laws and regulations that are investor
friendly have proliferated. Between 1991 and 2001, for instance, a total of 1,393
regulatory changes were introduced in national FDI regimes, of which 1,315 (or
95 percent) were in the direction of creating a more favorable environment for
FDI (World Bank 2003). Countries, such as Ghana, that once experimented with
the dependency theory have achieved neither prosperity nor greater economic
independence. Rather they have experienced much poverty, misery and greater
dependence on international aid and charity (Ahiakpor 1985).
The Middle-Path Theory.
The intervention or integrative school (the middle path theory) attempts to
analyze FDI from the perspective of the host country as well as that of the
investor. It incorporates arguments from both the classical and dependency
theorists. The theory posits that foreign investment must be protected but only to
the extent of the benefits it brings the host state and the extent to which foreign
investors have behaved as good corporate citizens in promoting the economic and
social objectives of the host country (Sornarajah 1994). The theory calls for a
mixture of intervention (regulation) and openness in dealing with foreign

43
investment and cautions against too much openness and too much regulation or
intervention (Seid 2002). The theory recognizes that there are instances where the
market is better placed to act and other instances where government intervention
is necessary. What is needed therefore is a balancing act between those activities
that can best be handled by the market and those that can be done by the
government.
The notion that governments and markets are complements and not substitutes
stands in stark contrast to earlier views which held the position that the existence
of one required the diminution of the other. In the 1950s and 1960s, the state in
many developing countries was the primary player in economic matters (Rodrik
1997). Following the debt crisis of the 1980s, major reforms were introduced
which sought to limit and confine the role of government to the provision of
public goods such as securing property rights, maintaining macroeconomic
stability and providing education and the necessary infrastructure (Rodrik 1997).
This idea of a limited government role in the market, often dubbed the
"Washington Consensus", was and has been actively promoted by the World
Bank and IMF.
The term 'Washington Consensus', coined originally in 1990 by John
Williamson to describe a set of market reforms that Latin American
economies could adopt to attract private capital following the debt crisis
of the 1980s, called for reforms in at least ten key areas (Clift 2003;
Williamson 2000). These areas were fiscal discipline, tax reform,
interest rate liberalization, a competitive exchange rate, trade
liberalization, a reduction of public expenditure, liberalization of inflows
of foreign direct investment, privatization, deregulation and secure
property rights (Maxwell 2005; Williamson 2000:252-53; Clift 2003:9).
In essence, these reforms require the state, beyond its provision of the

44
necessary market institutions, to play a minimal role in the market.
Although initially targeted at Latin American countries, these reforms
have become a common prescription that is advanced by the World
Bank/IMF for developing countries.
Ironically, even as it acknowledged the complementary roles between the state
and markets in promoting economic growth, the World Bank maintained in its
1991 Development Report that state interventions even when market-friendly
should be reluctantly pursued. Markets were to be allowed to work unless it was
demonstrably better for government to step in (World Bank 1991). Although
important, the state's role in economic development in this 'market-friendly'
approach is to be limited to providing social, legal and economic infrastructure
and to creating a suitable climate for private enterprise (Singh 1994). This
"market-friendly" approach, which requires a limited government role has been
found wanting following the East Asian economic success or miracle.
In its 1993 Report, the World Bank acknowledged that the economic success of
East Asian countries, particularly Hong Kong, South Korea, Singapore and
Taiwan, came not simply because these countries had the basics right (stable
macroeconomic policy, high savings rates and investment rates, physical and
human capital, economies that were export oriented, and the use of incentives and
application of selective import barriers) but because in most of these economies
the government intervened systematically and through many channels to foster
development and in some cases to develop specific industries (World Bank 1993)
Markets failures notwithstanding, government interventions may also be
inefficient. As Whiteley (1986) remarks, a state can intervene in the economy to

45
make things worse; it can protect 'sunset' industries rather than 'sunrise' industries;
it can give monopolistic privileges to support groups and it can invest in the
wrong areas, where state capacity is weak, state intervention can do more harm
than good (World Bank 1997). A study by Papanek (1992) found, for instance,
that excessive state intervention in the economies of India, Pakistan, Sri Lanka
and Bangladesh deterred economic growth and development in these countries.

46
2.4.2 FDI CONSTRAINTS IN AFRICA.
Various explanations have been adduced for Africa’s poor FDI record. In the
empirical literature, the following factors are important determinants of FDI flows
to the region.
Political instability.
The region is politically unstable because of the high incidence of wars, frequent
military interventions in politics, and religious and ethnic conflicts. There is some
evidence that the probability of war––a measure of instability––is very high in the
region. In a recent study, Rogoff and Reinhart (2003) computed regional
susceptibility to war indices for the period 1960-2001. They found that wars are
more likely to occur in Africa than in other regions. The regional susceptibility to
war index is 26.3% for Africa compared to 19.4% and 9.9% for Asia and the
Western Hemisphere respectively. The study also showed that there is a
statistically significant negative correlation between FDI and conflicts in Africa.
Sachs and Sievers (1998) have also argued that political stability is one of the
most important determinants of FDI in Africa.
Macroeconomic instability.
Instability in macroeconomic variables as evidenced by the high incidence of
currency crashes, double digit inflation, and excessive budget deficits, has also
limited the regions ability to attract foreign investment. Recent evidence based on
African data suggests that countries with high inflation tend to attract less FDI
(Onyeiwu and Shrestha, 2004).

47
Lack of policy transparency.
In several African countries it is often difficult to tell what specific aspects of
government policies are. This is due in part to the high frequency of government
as well as policy changes in the region and the lack of transparency in
macroeconomic policy. The lack of transparency in economic policy is of concern
because it increases transaction costs thereby reducing the incentives for foreign
investment.
Inhospitable regulatory environment.
The lack of a favourable investment climate also contributed to the low FDI trend
observed in the region. In the past, domestic investment policies––for example on
profit repatriation as well as on entry into some sectors of the economy––were not
conducive to the attraction of FDI (Basu and Srinivasan, 2002). Costs of entry, as
a percentage of 1997 GDP per capita, are very high in Africa relative to Asia.
Within Africa, the costs are higher in Burkina Faso (133.4%), Senegal
(99.6%), Nigeria (99.3%), and Tanzania (86.8%).
GDP growth and market size.
Relative to several regions of the world, growth rates of real per capita output in
Africa are low and domestic markets are quite small. This makes it difficult for
foreign firms to exploit economies of scale and so discourages entry. Elbadawi
and Mwega (1997), show that economic growth is an important determinant of
FDI flows to the region.

48
Poor infrastructure.
The absence of adequate supporting infrastructure: telecommunication; transport;
power supply; skilled labour, discourage foreign investment because it increases
transaction costs. Furthermore poor infrastructure reduces the productivity of
investments thereby discouraging inflows. Asiedu (2002b) and Morrisset (2000)
provide evidence that good infrastructure has a positive impact on FDI flows to
Africa. However, Onyeiwu and Shrestha (2004) find no evidence that
infrastructure has any impact on FDI flows to Africa.
High protectionism.
The low integration of Africa into the global economy as well as the high degree
of barriers to trade and foreign investment has also been identified as a constraint
to boosting FDI to the region. Bhattachrya, Montiel and Sharma (1997) and
Morrisset (2000) argue that there is a positive relationship between openness and
FDI flows to Africa.
Other factors that account for the low FDI flows to the region but are rarely
included in empirical
studies––presumably due to data limitations–– include:
High dependence on commodities.
Several African countries rely on the export of a few primary commodities for
foreign exchange earnings. Because the prices of these commodities are highly

49
volatile, they are highly vulnerable to terms of trade shocks, which results in high
country risk thereby discouraging foreign investment.
Increased competition.
Globalization has led to an increase in competition for FDI among developing
countries thereby making it even more difficult for African countries to attract
new investment flows. Relative to other regions of the world, Africa is regarded
as a high-risk area. Consequently foreign investors are reluctant to make new
investments in––or move existing investments to––the region. The intensification
of competition due to globalization has made an already bad situation worse. It
must be pointed out that the intense competition resulting from trade and financial
liberalization puts African countries at a disadvantage because they have failed to
take advantage of the globalization process––for example, through deepening
economic reforms needed to increase their competitiveness and create a
supportive environment for foreign investment.
Corruption and weak governance.
Weak law enforcement stemming from corruption and the lack of a credible
mechanism for the protection of property rights are possible deterrents to FDI in
the region. Foreign investors prefer to make investments in countries with very
good legal and judicial systems to guarantee the security of their investments.
2.5 FDI IN NIGERIA.
Brief Introduction.

50
The role of foreign direct investment in the development of Nigerian economy
cannot be over emphasized. Foreign direct investment (FDI) not only provides
developing countries (including Nigeria) with the much needed capital for
investment, it also enhances job creation, managerial skills as well as transfer of
technology. All of these contribute to economic growth and development. To this
end, Nigerian authorities have been trying to attract FDI via various reforms. The
reforms included the deregulation of the economy, the new industrial policy of
1989, the establishment of the Nigeria Investment Promotion Commission (NIPC)
in 1995, and the signing of Bilateral Investment Treaties (BITs) in the late 1990s.
Others were the establishment of the Economic and Financial Crime Commission
(EFCC) and the Independent Corrupt Practices Commission (ICPC). Before
transitioning to democracy in 1999, Nigeria had been experiencing declining and
fluctuating foreign investment inflows. Besides, Nigeria alone cannot provide all
the funds needed to invest in various sectors of the economy, to make it one of the
twenty largest economies in the world by 2020 and to meet the Millennium
Development Goals (MDGs) in 2015.
Economic Backdrop.
At independence, in addition to being a leading exporter of groundnut, Nigeria
accounted of 16 and 43 percent of world cocoa and oil-palm respectively. The
country was largely self-sufficient in terms of domestic food production (85%)
and Nigerian agriculture contributed to over 60 percent of GDP and 90 percent of
exports. Conversely, manufacturing was less than 3percent of GDP and 1 percent
of exports, while the oil sector represented only 0.2 percent of GDP.

51
At this time, foreign presence in the economy was significant. More than 25
percent of companies registered in Nigeria in 1956 were foreign-owned while in
1963 as much as 70 percent of investment in the manufacturing sector was from
foreign sources (ohiorhenuan, 1990). Most FDI was from the Middle East and the
United-Kingdom and concentrated on commerce and cash-crops.
The First National Development Plan (1962-1968) sought to broaden the base of
the economy and limit the risk of over-dependence of foreign trade (okigbo,
1990). In keeping with developmental rhetoric of that era, the tariff structure was
formulated with industralisation and import substitution in mind. Manufacturing
initially responded albeit slowly to the new policy but with foreign exchange and
import licensing controls introduced in 1971-72, the progress halted.
In addition to industrialization, removing of the dominance of foreign entities in
the Nigerian economic landscape was of major public concern. Legislation that
signified economic independence through nationalization of assets and state led
investment in public institutions was adopted.
The second National Development Plan (1970-1974) accelerated indigenization
on grounds that it was vital for Government to acquire, by law if necessary, the
greater proportion of the productive assets of the economy. Restrictions were
therefore imposed on the activities of foreign investors with the first
indigenization decree adopted in 1972. Further restrictions were imposed in the
second indigenization decree in 1977. The result has been described as among the
most comprehensive joint venture schemes in Africa and the developing world at

52
large (Biersteker, 1987). The numbers of activities reserved exclusively for
Nigerians were expanded to include a wide range of basic manufactures. Foreign
firms were compelled to enter into joint ventures with local capitals or the state.
Many foreign investors-such as IBM, Chase Manhattan Bank and Citigroup-
divested during this period.
The third National Development Plan (1975 -1980) was framed after the world
price of crude oil quadrupled (1973) and the share of oil in total exports reached 90
per cent. In this setting, exchange controls were reduced and restrictions on import
payments abandoned. Public expenditure increased sharply and the Naira
appreciated, further eroding agricultural competitiveness. Additional incentives
for industrialization were adopted, including pioneer status and fast depreciation
allowance on capital goods. These incentives produced a temporary increase in
manufacturing output, which grew on average 14 per cent per annum between
1975 and 1980, compared to 6 per cent in services. On the other hand,
agriculture production shrank by 2 per cent annually over the same period.
Following the major decline of oil prices in the early 1980s, the shortcomings of past
economic planning were exposed. Agriculture accounted for less than 10 per cent of
exports and the country had become a net food importer. Manufacturing output
started falling at about 2 per cent per annum between 1982 and 1986 while GDP
stagnated, with less than 1 per cent growth annually. Furthermore, by 1986, there
were about 1,500 State-owned enterprises, of which 600 were under the control of
the federal Government and the remainder under State and local Governments.

53
The evidence suggests that many made no contribution to Nigeria’s productive
capacities and many enterprises were not financially viable (Mahmoud, 2004).
The cumulative effect of these policies is that Nigeria has not undergone
fundamental structural change experienced by other developing countries in the
last 40 years. Manufacturing still reperesents only 4% of GDP compared with 14%
around the rest of sub-saharan Africa. Maintenance spending are at levels close to
zero leading to a sharp deterioration in water supply, sewage, sanitation, drainage,
roads and electricity infrastructure (Worldbank 1996). Hence, the misallocation of
public finances has taken a heavy toll on the state of basic infrastructure.
In order to restore economic prosperity and address external shocks such as the
global recession of the early 1980s, the Government initiated a series of austerity
measures and stabilization initiatives in 1981- 1982. These, however, proved
unsuccessful and a structural adjustment programme (SAP) followed. The SAP
(1986 -1988), which emphasized privatization, market liberalization and
agricultural exports orientation, was not implemented consistently and was at odds
with other facets of policy, e.g. tariff increases. But an economic reform process,
which continues to the present, has it origins in this period. Following the return
to democracy in May 1999, the reform process was re-energized, mainly through
Nigeria’s home-grown poverty reduction strategy. The National Economic
Empowerment and Development Strategy (NEEDS), adopted in 2003, and was
followed a highly participatory process as important stake-holders such as the
private sector have been carried along. Associated poverty reduction strategies
were developed at the State and local levels - State Economic Empowerment and

54
Development Strategies (SEEDS) and Local Economic Empowerment and
Development Strategies (LEEDS).
NEEDS, SEEDS and LEEDS were major departures from the policies of the past.
Their broad agenda of social and economic reforms was based on four key strategies
to:
• Reform the way government works in order to improve efficiency in
delivering services, eliminate waste and free up resources for investment
in infrastructure and social services.
• Make the private sector the main driver of economic growth by turning the
government into a business regulator and facilitator.
• Implement a social charter which include improving security, welfare and
participation and
• Push a value-re-orientation by shrinking the domain of the state and hence
the pie of distributable rents which have been the haven of public sector
corruption and inefficiency.
In contrast with previous development plans, NEEDS made FDI attraction an
explicit goal for the Government and paid particular attention to drawing
investment from wealthy Nigerians abroad and from Africans in the Diaspora.

55
2.5.1 FDI ORIGIN IN NIGERIA
The oil industry has been the largest single beneficiary of FDI in Nigeria.
Companies such as Exxon-Mobil (U.S.A), Shell (Dutch), Total (French) e.t.c. are
some of the biggest players in the Nigerian Oil industry. However, Chinese
investments are increasing in Nigeria across sectors. In Africa, South-African
investments are on the rise. Companies such as Multi-choice, True love magazine,
and MTN in mobile telecommunications are examples of firms originating from
south-Africa. Also, from the Middle-East we have Etisalat and Bharti-Airtel (the
new owners of Zain)
Nigeria’s economy is similar in several respects to other low income developing
economies in Africa but is significantly different in its considerable oil and gas
resource base and the large size of the domestic market. In contrast to other large
oil producers, Nigeria has not managed to use oil resources to diversify its
economy and move towards higher productivity sectors. The advantage of a
relatively large domestic market has not delivered efficiency gains for domestic
firms. We will examine the impact of FDI in three important sectors of the
Nigerian economy, namely oil, manufacturing and telecommunications.
The economy is dominated by oil which has risen in importance from 29 percent
of GDP in 1980 to 52 percent in 2005. Oil and gas contribute about 99 percent of
exports and provide about 85 percent of government revenues however its
contribution to employment is limited—estimated at around 4 percent. Public
ownership of oil has also allowed extension of the public sector evidenced in
historically much higher share of government spending in GDP than in other

56
developing countries. Direct foreign investment has been instrumental in the
development of oil extraction to a point where Nigeria is now the 11th largest oil
producer in the world and the largest in Africa. MNCs have been able to deploy
capital and technology on a scale beyond Nigeria’s domestic resources. They have
been especially significant in exploration and extraction from difficult areas, such
as deepwater reserves in the Gulf of Guinea. However, FDI has not been prominent
in the downstream side of the oil industry. For example, Nigeria imports refined
products accounting for 21 percent of total imports.
FDI has not shown real impact on the development of Nigeria’s manufacturing
sector. The industry has stagnated over a period of 30 years either due to
inhospitable business environment or dilapidated infrastructure. Manufacturing
exports have revived since the 1990s. But they are not appreciably greater now
than in 1965 (in constant United States dollars) and have halved on a per capita
basis. In comparative terms, exports per capita in 2003 were $493 in South Africa,
$59 in Egypt, $24 in Kenya and $3 in Nigeria for the same group of manufactures.
The manufacturing sector is similarly strongly oriented towards food and
beverages for the domestic market, accounting for between 50- 60 percent of
manufacturing GDP. The largest component of the services sector is wholesale
and retail trade, of which food and beverages represent close to 90 percent, with
domestically produced food and beverages accounting for the overwhelming
proportion of value added. Food and beverages therefore account for between 50-
60 percent of
non-oil GDP.

57
FDI has had a notable impact on the expansion of mobile telephony in Nigeria
since the launch of Global System for Mobile (GSM) licensing in January 2001.
Two of the three licenses issued went to foreign companies- MTN of South Africa
and Econet Wireless (Now Zain Nigeria) for $285 million each, a year later
globacom, Nigeria’s second national carrier was granted license. The impact of
FDI under competitive conditions in mobile telephony has been remarkable. In
the sector as a whole, subscriber numbers have grown from 35,000 to over 16
million by September 2005. Prior to the licensing of the Digital Mobile Operators,
private investment in the telecommunications sector was just about US$50
million. Between 2001 and now, the sector has attracted over US$9.5 Billion,
substantial part of which are direct foreign investment. Nigeria has thus become
one of the most desired investment destinations for ICT in Africa. In addition to
this, the Federal government has earned over US$2.5 Billion from Spectrum
licensing fees alone between 2001 and now. Import duties and taxes from the
telecom industry have also contributed substantial revenue to the Federal
Government.

58
2.5.3 FDI PROMOTION IN NIGERIA.
Privatisation.
Privatisation has also become an important source of FDI over the last two
decades. Nigeria has implemented two rounds of privatization since the 1980’s-
the first one (1986-1993) as part of the structural adjustment programme and the
second one since the return to democracy in 1999.
During the first privatization wave, foreign investors were excluded from bidding
in all sectors except oil. This was effectively the last major expression of the
indigenization policy. The sale of oil interests to Elf Aquitaine for $500 million
in 1992, however, represented almost two thirds of the total proceeds from
privatization ($740 million).
In contrast, the second privatization wave, originally scheduled to last from 1999
to the end of 2003, focused on attracting foreign investment. By then, the 1995
landmark NIPC decree was in place. Almost 100 enterprises were targeted for
privatization or commercialization in three phases.
There are indications that FDI inflows to sectors other than oil and gas are reacting
positively to the various reforms to the investment climate carried out since 1999.
Several non-oil sector MNCs have expanded production in Nigeria. For example,
Heineken invested 250 million Euros in purchasing and expanding Nigeria
Breweries in 2004. MTN, the largest mobile telephony operator in Nigeria, has
invested over $3 billion in the sector between 2001 and 2006, and has expressed
commitment to ongoing expansion.

59
Establishment of Free Trade Zones
As part of initiatives to promote FDI in Nigeria the Nigerian Free Zone Act
(1992) was passed establishing the Nigerian Export Processing Zone Authority
(NEPZA). Free trade zones (FTZ), so renamed in 2001, are expanses of land with
improved ports and/or transportation, warehousing facilities, uninterrupted
electricity and water supplies, advanced telecommunications services and other
amenities to accommodate business operations. Under the free zone system, as
long as end products are exported (although 25% can be sold in the domestic
market), enterprises are exempt from customs duties, local taxes, and foreign
exchange restrictions, and qualify for incentives—tax holidays, rent-free land, no
strikes or lockouts, no quotas in EU and US markets, and, under the 2000 African
Growth and Opportunity Act (AGOA), preferential tariffs in the US market until
2008. When fully developed, free zones are to encompass industrial production,
offshore banking, insurance and reinsurance, international stock, commodities,
and mercantile exchanges, agro-allied industry, mineral processing, and
international tourist facilities.
As of 2003, Nigeria had five free trade zones (FTZs) being developed. The most
advanced is the Calabar FTZ in the southeast; established in 1992 with
accommodations for 80 to 100 businesses, it had only 6 companies in 2001. By
May 2003, however, 76 licenses had been issued for the Calabar FTZ and 53
enterprises were operating. The Calabar harbor, which was scheduled for further
dredging, serves mainly as a berthing port for textile and pharmaceutical products.
The Onne Oil and Gas FTZ near Port Harcourt had about 85 registered oil and gas

60
related enterprises, and was generating about $1.2 million in government revenue
annually. The other three FTZs—at Kano, Maigatari, and Banki—were still at the
stage of infrastructure construction. Under the related Export Processing Zones
(EPZ) initiative 7 factory sites in Ondo, Akwa-Ibom and Kano states, with
another 12 under construction in Lagos, have received infrastructure
improvements, tax exemptions, and incentives to reduce their production costs in
order to make their exports more competitive. There are also five export-
processing farms (EPFs), selected for their export potential to receive site
improvements, exemptions, and incentives. Finally, Singaporean interests have
spent about $169 million developing the private Lekki FTZ.
Nigeria's FTZ regulatory regime is liberal and provides a conducive environment
for profitable operations. The incentives available are among the most attractive
in Africa and compares favourably with those in other parts of the world. These
include:
• Exemption from all federal, state and local government taxes, levies and
rates.
• Approved enterprises shall be entitled to import into a zone, free of
customs duty on capital goods, consumer goods, raw materials,
components and articles intended to be used for purposes of and in
connection with an approved activity.
• Freedom from legislative provision pertaining to taxes, levies, duties and
foreign exchange regulations.
• Repatriation of foreign capital on investment in the zone at any time with
capital appreciation of the investment.
• 100% foreign or local ownership of factory allowable.

61
• One stop approvals which grant all licenses whether or not the business is
incorporated in the Customs Territory.
• Unrestricted remittance of profits earned by investors.
• Permission to sell 100% of total production in the domestic market.
• No import or export license.
• Rent free land at construction stage, thereafter rent shall be as determined
by the management of the zone. Foreign managers and qualified personnel
may be employed by companies operating in the zones.
2.5.4 FDI BENEFITS IN NIGERIA
In its base document, the New Partnership for Africa's Development (NEPAD)
emphasizes the importance of Foreign Direct Investment (FDI) to Africa's long-term
development. Aaron (1999) provides evidence on the positive impact of FDI on
employment in developing countries.
Employment generation and growth
By providing additional capital to a host country, FDI can create new employment
opportunities resulting in higher growth. It can also increase employment
indirectly through increased linkages with domestic firms.
Supplementing domestic savings.
African countries have low savings rates thereby making it difficult to finance
investment projects needed for accelerated growth and development. Available
data indicate that in Sub-Saharan Africa gross domestic savings as a percentage of

62
GDP fell from 21.3% over the period 1975-84 to 17.4% in the period 1995-2002.
Furthermore, the gap between domestic savings and investment was -1.9% of
GDP over the period 1975-84 and -1.0% of GDP during the period 1995-2002.
FDI can fill this resource gap between domestic savings and investment
requirements. Integration into the global economy: Openness to FDI enhances
international trade thereby contributing to the integration of the host-country into
the world economy (Morrisset, 2000).
Raising skills of local manpower.
Through training of workers and learning by doing, FDI raises the skills of local
manpower thereby increasing their productivity level. The idea that FDI enhances
the productivity of the labour force is supported by empirical evidence suggesting
that workers in foreign-owned enterprises are more productive than those in
domestic-owned enterprises (Harrison,1996).
Transfer of modern technologies.
Foreign firms typically make significant investments in research and
development. Consequently they tend to have superior technology relative to
firms in developing countries. FDI gives developing countries cheap access to
new technologies and skills thereby enhancing local technological capabilities and
their ability to compete on world markets. Blomstrom and Kokko (1998) provide
an interesting survey of the literature on FDI and transfer of technology.

63
Enhanced efficiency.
Opening up an economy to foreign firms increases the degree of competition in
product markets thereby forcing domestic firms to allocate and use resources
more efficiently.
2.6 DETERMINANTS OF FDI FLOWS
Earlier theoretical and empirical studies on FDI have adopted either one or a
combination of two approaches. The first or the ‘pull-factor’ approach examines
the relationship between host-country specific conditions and the inflow of FDI.
Under this approach FDI is either classified as (i) import-substituting; (ii) export-
increasing or (iii) government-initiated (Moosa 2002). The second or the ‘push-
factor’ approach leans towards examining the key factors that could influence or
motivate multinational corporations (MNCs) to want to expand their operations
overseas. Under this second approach, FDI is either classified as horizontal or
market seeking, vertical or conglomerate (Caves 1971, 1974; Moosa 2002). Some
factors that attract FDI as empirically validated include:
Return on Investment in the Host Country.
The profitability of investment is one of the major determinants of investment.
Thus the rate of return on investment in a host economy influences the investment
decision. Following previous studies (see Asiedu, 2002), the log of inverse per
capita has been used as proxy for the rate of return on investment as capital scarce
countries generally have a higher rate of return, implying low per capita GDP.

64
This implies that the lower the GDP per capita, the higher the rate of return and
thus FDI inflow.
Relative Size of market and growth.
The aim of FDI in emerging developing countries is to tap the domestic market,
and thus market size does matter for domestic market oriented FDI. Econometric
studies comparing a cross section of countries indicate a well-established
correlation between FDI and the size of the market (proxied by the size of GDP),
average income levels and growth rates. The size of the market or per capita
income are indicators of the sophistication and breath of the domestic market.
Thus, an economy with a large market size (along with other factors) should
attract more FDI. The prospect of growth also has a positive influence on FDI
inflows. Countries that have high and sustained growth rates receive more FDI
flows than volatile economies. There are good number of studies showing the
positive impact of per capita growth or growth prospect on FDI (Schneider and
Frey, 1985; Lipsey,1999; Dasgupta and Rath, 2000; and Durham, 2002).
Openness and export promotion.
The key hypothesis from various theories is that gains from FDI are far higher in
the export promotion (EP) regime than the import promotion regime. The theory
proposes that import substitution (IS) regimes encourage FDI to enter in cases
where the host country does not have advantages leading to extra profit and rent-
seeking activities. However in an EP regime, FDI uses low labor costs and
available raw materials for export promotion, leading to overall output growth.
The ratio of trade (imports + exports) to GDP is often used as a measure of

65
openness of an economy. This ratio is also often interpreted as a measure of trade
restrictions. A range of surveys suggests a widespread perception that `open'
economies encourage more foreign investment. Trade openness generally
positively influences the export-oriented FDI inflow into an economy (Housmann
and Fernandez-arias (2000), Asidu (2001)). Overall, the empirical literature
reveals that one of the important factors for attracting FDI is trade policy reform
in the host country. Investors generally want big markets and like to invest in
countries which have regional trade integration, and also in countries where there
are greater investment provisions in their trade agreements. Excessive trade
liberalization in the host country may induce MNCs to export to that market
instead of producing there. Import liberalization may also however stimulate
competition, thereby encouraging foreign firms to transfer technology to their
affiliates in the liberal market to maintain competitiveness Blomström et al.
Labour costs and productivity.
Cheap labor is another important determinant of FDI inflow to developing
countries. A high wage-adjusted productivity of labor attracts efficiency-seeking
FDI both aiming to produce for the host economy as well as for export from host
countries. Empirical research has also found relative labour costs to be
statistically significant, particularly for foreign investment in labour-intensive
industries (the use of unskilled labour is prevalent) and for export- oriented
subsidiaries. The decision to invest in China, for example, has been heavily
influenced by the prevailing low wage rate.

Determinants of Foreign Direct Investment in Nigeria (1977-2008) OLADAPO TOLULOPE AJAYI

Determinants of Foreign Direct Investment in Nigeria (1977-2008) OLADAPO TOLULOPE AJAYI

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