The economic growth and foreign direct investment nexus: Does democracy matter? Evidence from African countries

• Date: 01 July 2018
• Author: Atif Awad,Hoda Ragab
• Published date: 01 July 2018
• DOI: http://doi.org/10.1002/tie.21948

EMERGING MARKET PERSPECTIVES: AFRICA

The economic growth and foreign direct investment nexus:

Does democracy matter? Evidence from African countries

Atif Awad

1

| Hoda Ragab

2

1

University of Sharjah, UAE

2

Curtin University, Australia

Correspondence

Dr. Atif Awad, University of Sharjah, P.O. Box

27272, Sharjah, UAE.

Email: aawoad@sharjah.ac.ae

This article investi gates the impact of de mocracy on the foreign d irect investment (FD I)–

economic growth nexu s by considering both a cou ntry's current and pas t political regimes.

We apply a linear dynami c panel data model to data f rom 53 African countr ies over the

period 1989–2014. Standard error s of the estimates are Weidm eijer corrected, foll owing an

orthogonal deviati ons transformation . The results show that th e direct impact of FDI o n

growth is positive and si gnificant. Likewis e, the stock of democrac y plays a positive and si g-

nificant role in the gr owth process. However, the positive impa ct of FDI on growth decreases

with the improvement i n the historical exper ience of a country with d emocracy. These find -

ings imply that with contemporary efforts to expand political rights in Africa, it is critical to

identify alternative channels that facilitate the transmission of the flow of FDI into further

and sustainable grow th.

KEYWORDS

democracy, economic growth, FDI

1|INTRODUCTION

As a stock of physical cap ital, the empirical ev idence confirms that

foreign direct investment (FDI) plays a direct and substantial role in

the economic growth process in developing countries that lack capi-

tal. However, less at tention has been given to other importa nt indi-

rect mechanisms through which FDI can also contribute to such

growth. This is beca use the new growth the ory proposes that FDI

also has indirect effec ts arising from technol ogy spillovers and effi -

ciency gains (Elkomy, Ingham, & Read, 2016). The empirical litera-

ture has identified three channels through which technology can

spread from FDI to home companies: intraindustry (or horizontal)

spillovers, interindustry spillovers (vertical linkages) and both intra-

and inter-industry s pillovers (Iványi & Vi gvári, 2012). Since th e spill-

over processes are no t automatic, there ar e several variables, them-

selves complexly in terrelated, which d etermine how strong each

channel can be. In most host economies, probably all the channels

mentioned above are a t work at some point, b ut the level of tech-

nology transfer that actually happens depends on a number of fac-

tors (Blomstrom, Gl oberman, & Kokko 1999 ). These factors incl ude,

for example, the level o f competition and the st ructure of the host

market; the size of th e host market; techn ological competenci es of

host-country firms ; the capacities of wor kers to learn and ado pt

new technologies; a nd the amount, type, an d intensity of verti cal

linkages between dom estic firms and foreign affiliates (Ivá nyi & Vig-

vári, 2012). Thus, it is g enerally recognize d that the absorptive

capacity of the recipient country is the key determinant of whether

FDI has a positive, in significant, or ne gative spillover ef fect on eco-

nomic growth.

While the impacts of several FDI-enhancing growth variables

have been considered extensively in previous studies, the influence

of the political regime in enhancing economic growth responses to

FDI has not received as much attention. The literature on the impact

of democracy on the FDI–economic growth nexus shows a contro-

versial indefinite relationship; a theoretical point of view sees the

impact of democracy on FDI to be unclear. More specifically, there

are several ways that democratic institutions may have a positive

effect on FDI and consequently economic growth: through checks

and balances on elected officials, reducing arbitrary government

intervention, lowering the risk of policy reversal, and strengthening

property rights protection (Q. Li, 2009; North & Weingast, 1989). In

contrast, multinational corporations (MNCs) and foreign aid donors

may prefer to invest in autocratic countries, as autocratic govern-

ments are not directly accountable to their electorates. Hence,

DOI: 10.1002/tie.21948

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