Download New Evidence from ECOWAS Countries Using

Foreign Direct Investment, Governance and Economic
Growth Trilogy: New Evidence from ECOWAS Countries
Using Threshold Analysis Threshold
By
Ibrahim D. RAHEEM*
*Department of Economics, University of Ibadan, Ibadan Nigeria.
I_raheem @ymail.com. +2347032659866
Using a panel data from 7 Economic Community of West African State (ECOWAS) countries
employing Ordinary Least Square (normal and fixed effect) and Threshold Auto Regressive (TAR)
model, this study examines the interactive impact of governance on Foreign Direct Investment
(FDI) – economic growth nexus. The study finds that FDI is positively related to growth in both
normal effect and dynamic effect in the linear regression (OLS). Also, government consumption,
Balance of Payment (BOP) and Governance contribute significantly to the growth process of the
countries under study. For the non-linear effect (TAR), the study uses governance to act as
sample split variable. The study further conducted the Likelihood Ratio test and obtained a
value of about 3.326. The implication of the result obtained is that the positive effect of FDI
would begin to manifest once governance reaches the threshold level of -1.2. The policy
recommendation drawn from this is that policy makers should formulate policies that are not
limited to attracting FDI alone but also that of FDI.
INTRODUCTION
The importance of economic growth cannot be overemphasized. Economic growth has
often been used as a deciding factor for membership into group of influential Countries.
The literature on economic growth shows diverse channels through which growth can be
achieved. A prominent channel is through investment. The role played by externally
financed investment in spurring growth is huge. Countries therefore lay emphasis on
various efforts to drive Foreign Direct Investment (FDI)
Economic growth is driven by certain economic activities which among other things,
include policies and directives instituted by the government; as the government policies
and institutions that make up the infrastructure of an economy determine investment and
productivity, and therefore also determine the wealth of nations. (Jones, 1998).
In recent times, developing countries, especially in Africa see the role of FDI as crucial to
their development. FDI is seen as an engine of growth as it provides the much needed
capital for investment, increases competition in the host country industries, and aid local
firms to become more productive by adopting more efficient technology or by investing in
human and/or physical capital. FDI contributes to growth in a substantial manner because
it is more stable than other forms of capital flows because of its ownership structure1. The
benefits of FDI include serving as a source of capital, employment generation, facilitating
access to foreign markets, and generating both technological and efficiency spillover to
local firms. FDI is the largest source of external finance of developing countries, and the
inward stock of FDI in 2000 amounted to around one-third of their GDP, as compared to
just 10 percent in 1980 (UNCTAD, 2006).
It is expected that by providing access to foreign markets, transferring technology and
generally building capacity in the host country firms, FDI will inevitably improve the
1
The minimum required level is 10% as stated by Ayanwale (2007). Hill (2003), OECD (1996) and Adeoye (2009)
used the words “control” and “long term” to make distinction between FDI and portfolio investment.
integration of the host country into the global economy and foster growth. FDI is seen as a
key driver of economic growth and development. FDI not only boosts capital formation but
also enhances the quality of capital stock. Though, the importance of FDI has been critized
on the basis that it might lead to crowding out effect of the indigenous companies. In
addition to this, Hill (2003) posits that FDI might adversely have effects on the host
country’s balance of payments and the perceived loss of national sovereignty and
autonomy. Though, these criticisms are logical and constructive but it is imperative to state
that the benefits outweigh the cost.
The empirical evidence to date on the effect of FDI on economic performance, however, is
not conclusive. While some studies have indicated a positive impact of FDI on economic
growth, other studies report otherwise. A third group of studies suggest that the effect of
FDI on a host country's economy is dependent on the country's absorptive capacity in
terms of its human capacity, the level of development, and financial development
(Borenstein et al. 1998; Hermes and Lensink, 2004; Alfaro et al, 2000). The extent to which
FDI contributes to growth depends on several factors. These include rate of savings in the
host country, the degree of openness and the level of technological development, among
others. FDI will have a positive effect on the growth prospect of the recipient economy if
the host country has a high savings rate; an open trade regime and high technology (see
Akinlo 2004).
A country’s institutional framework that could engender the ideal absorptive capacity that
attracts FDI largely lean on good governance. Governance is broadly defined as “the
traditions and institutions that determine how authority is exercised in a country”
(Kaufmann et al. 2005). However, worthy of note that the relationship between governance
and growth is ambiguous in most developing countries which forms the core of Sub-Sahara
African countries (SSA), basically because of structural and fiscal constraints as well as
attitudinal limitations. Ngov (2011) stated that the definition and the usage of governance
remains unclear and differs depending on the users.
The virtues of good governance had been highly extolled by several international
organizations and numerous claims were made that it is one of the precondition for
economic development take off (Litjobo, 2005). A growing volume of available literature
suggests that lack of quality governance hinders growth and investment, and aggravates
poverty and inequality. In fact, governance problem foils every effort to improve
infrastructure, attract investment, and raise educational standards. Weak governance
poses a major challenge not only to further gains in development but also to sustain
economic growth achieved so far (Roy, 2005).
A number of efforts have been put in place by the government to attract FDI inflow into the
country. Policies such as tax rebate and holidays, low interest loan, grants, subsidies,
increased spending on infrastructure, creation of export processing zones and other
concessions have been put in place to attract FDI inflow. It appears that the benefits of such
flow might be short lived based on the ability of stakeholders to create an enabling and
business friendly environment that can exhibit high level of governance and environments
that is free from corruption.
The importance of this study emerged from the fact that not much attention has been
devoted to the triplex issue of governance, FDI and growth. It is the objective of this study
to determine the relationship between governance and FDI-growth nexus. To achieve this,
we employ Threshold Auto Regressive (TAR) model as our estimation technique. The
advantage of this methodology is its ability to determine the threshold level of governance
that would facilitate positive relationship between FDI-growth nexus. Prior to this
threshold, the benefit(s) of FDI is “non-existence”. The scope of this study is limited to
developing ECOWAS countries2 only so as to avoid bias of any form when developed and
developing countries are analysed simultaneously (Mensistu and Adam, 2007).
In sum, we are seeking answers to these questions: what is the relationship between
governance and FDI on economic growth process of a particular country? What effect
2
The countries are: Benin, Cote d’ Ivoire, Ghana, Nigeria Sierra Leone, Senegal and Togo. The choice of these
countries is based on data availability consideration.
would other control variables have on economic growth? Is the threshold value of
governance achievable?
The rest of the study following the introductory part is arranged as follows: section two
dwells on some stylized facts on FDI, governance and economic growth in the selected
ECOWAS Countries. Section three enumerates both theoretical and empirical issues of the
debate. It also gave a brief insight of the various governance indicators. In section four,
methodological issues are adequately treated and the result of the study is presented in
section five of the study. While section six wraps up the study by giving a conclusion of the
study and also to proffer policy recommendations.
2.1 Flows of FDI
This section is further divided into three parts. The first part discusses FDI’s flow on the global
perspective, a brief historical exposition of FDI into both developed and developing regions of
the world would be analysed. The second aspect of this sub-section focuses majorly on
developing countries while the last part would be dedicated to selected countries in Africa.
Global FDI Flow
Table 2.1:
Global FDI Flow (inward) as a Percentage of GDP (1970-2010)
1996-99
2000-04
World
100
100
Developing Economies
31.744
27.248
Developed Economies
66.901
69.011
Africa
1.607
2.474
America
24.785
18.833
Asia
18.606
16.871
Europe
39.112
46.152
LDCs
0.644
1.315
Source: Author’s Computation from UNCTADSTAT, 2011
2005-10
100
36.534
64.516
3.993
17.707
22.472
37.939
1.753
Average
100
31.842
66.809
2.691
20.775
19.316
41.068
1.244
From the Table 2.1 above, developed economies had continually had the largest share of the
global flow. The reasons attributed to this cannot be far fetched from the well developed and
organized infrastructures as well as stable government policies which could b considered as
major determinants of FDI. It is not surprising why the developing countries were only able to
attract about 32 per cent of the total flow despite the existing policies to attract FDI inflow.
Another reason could be linked to their inability to adequately provide pre-requisite
determinants of FDI (i.e. infrastructure, well functioning institutions, and stable policies to
mention but few).
Classifying the flow into regions, Europe recorded the lion share. It recorded an overall 41 per
cent of the total flow. This is followed by America, all through the period under study, its share
had been relatively stable with an overall average of about 21 per cent. The existence of the
“Asian Tigers” helped Asian region to record about 19 per cent.
The distribution of the flow has been biased against Africa. This pattern remains palpable in
spite of policy initiatives in a number of African countries and the significant improvements in
the factors governing FDI flows. These factors include, but are not restricted to, economic
reform, democratization, privatization and enduring peace and stability. The possible reason for
this can be related to the fact that FDI flow to countries in the region which can boast of natural
endowments (Oil and Agricultural product). Therefore, this means that major FDI inflows into
Africa are resource seeking FDI.
Regional Distribution of FDI
The Table 2.2 below clearly depicts that the larger share of the flow to developing countries
was recorded in the Asian countries. The region was able to attract over half of the total global
flow to developing countries. Asia was able to attract a weighted average of about 53 per cent.
America sits on the second step of the ladder with a share value of about 37 per cent. Africa
continent as a whole was only able to attract a meagre share as it was unable to attract 10 per
cent of the total flow to developing countries. A plausible reason to this might be related to
poor governance 3 among others. The same reasons explained above can also be attributed to
the case of LDCs.
Table 2.2: Share of FDI Flows to developing countries by Region, 1996-2010 (in percent)
1996 - 99
2000 - 04
2005 - 10
1996-2010
Developing Economies
100
100
100
100
Africa
4.818
7.252
9.567
7.212
Caribbean and American
41.140
36.181
32.502
36.608
Asia
51.772
52.688
53.491
52.650
Oceania
0.197
0.102
0.235
0.178
LDCs
2.073
3.777
4.205
3.352
Source: Author’s Computation from UNCTADSTAT, 2011
Pattern of FDI to Selected ECOWAS Countries
The table below indicates that the choice of investment by Multinational Corporation is Ghana,
which recorded an overall average of about 21 per cent. This is closely followed by Nigeria.
Prior to 2005, Nigeria has been in the front seat of recipients of FDI inflow in the continent.
However, due to what could be termed “evolutional years (beginning of 2005)”, Ghana took
over the position from Nigeria. This then justifies the industrialization plan of the Ghanaian
government. Côte d'Ivoire, Togo and Sierra Leone fairly did well as they were able to attract
over 10 per cent share of its GDP as FDI inflow.
Table 2.3: Share of FDI Flows to developing countries by Region, 1996-2010 (in percent)
1996-1999
2000-2004
2005-2010
1996-2010
Benin
4.085628
7.612007
13.27088
8.322838
Côte d'Ivoire
11.34497
9.592956
11.21472
10.71755
Ghana
8.312584
9.32453
44.99375
20.87695
Nigeria
18.33797
14.79952
23.04146
18.72632
Senegal
8.070866
5.024883
10.79535
7.963699
Sierra Leone
0.258741
10.74927
19.62079
10.2096
3
All the six indicators used by Kauffman et al (1999)
Togo
Source:
16.68217
Author’s Computation from UNCTADSTAT, 2011
Table 2.4a
Country
12.69089
11.59983
Governance Indicator4 for selected ECOWAS Countries
Voice and Accountability
1996200320072002
2006
2010
Political Stability
199620032002
2006
20072010
Government Effectiveness
1996200320072002
2006
2010
Benin
Cote d'
Ivoire
0.7358
0.4334
0.3639
0.2377
0.1464
0.3322
-0.3314
-0.4412
-0.5274
-0.9072
-1.3509
-1.1905
-0.8995
-2.077
-1.6808
-0.5205
-1.2122
-1.2451
Ghana
-0.2162
-0.2781
-0.4782
-0.8995
-1.0852
-1.6808
-0.1094
-0.1939
0
Nigeria
-0.8999
-0.717
-0.7875
-1.1347
-1.7325
-1.9175
-1.0081
-0.8528
-1.0866
Senegal
Sierra
Leone
0.1101
0.1522
-0.2491
-0.7043
-0.1825
-0.2263
-0.0568
-0.2397
-0.3955
-1.112
-0.4432
-0.2257
-1.7968
-0.557
-0.1855
-1.474
1.2196
-1.1876
-1.2192
-1.3081
-1.1348
-0.431
-0.685
-0.2273
-1.0974
-1.5471
-1.4453
Togo
Table 2.4b
Country
Benin
Cote d'
Ivoire
Ghana
Nigeria
Senegal
Sierra
4
5.426434
Governance Indicator5 for selected ECOWAS Countries
Regulatory Qualities
Rule of Law
1996200320071996200320072002
2006
2010
2002
2006
2010
-0.2566 -0.5169 -0.4235 -0.2212 -0.5607 -0.6415
Control of Corruption
1996200320072002
2006
2010
-0.7073 -0.6568 -0.5841
-0.4409
-0.2937
-0.9443
-0.1661
-1.3912
-0.5032
-0.1029
-1.1681
-0.2069
-0.8297
-0.887
-0.1971
-1.08
-0.2363
-1.1002
-0.8996
-0.0637
-0.804
-0.2913
-0.8844
-1.0745
-0.1636
-1.2375
-0.067
-1.3538
-1.4925
-0.0916
-1.3848
-0.1883
-1.141
-1.3533
-0.0563
-1.136
-0.2628
-0.9518
An update version of governance indicator created Kaufmann, Kraay and Mastruzzi (2010)
www.govindicators.org
5
An update version of governance indicator created Kaufmann, Kraay and Mastruzzi (2010)
www.govindicators.org
-1.1569
-0.2187
-1.2023
-0.1718
-0.9806
-1.0989
0.0471
-0.936
-0.5765
-0.8768
Leone
Togo
-0.5707 -0.7991 -0.8822 -0.6905
-1.028 -0.8735 -0.7101
Source: Authors computation from www.govindicators.org
0.9307
-0.9726
In the governance table above, Benin Republic performed fairly well than others on the average
when Voice and Accountability and Political Stability are used as indicators of governance. This
is followed by Senegal and Ghana respectively. In terms of political stability, Nigeria, Cote
d’Ivoire and Ghana is not encouraging as they sit at the bottom of the ladder. Available data
shows that overall, governments of Togo and Nigeria need to improve governance.
When governance is measured by regulatory quality, it is imperative to report that Benin led
the chart, followed by Ghana and Senegal. The same can also be said for Togo when rule of law
and control of corruption are used. In sum, it is can be equivocally be stated that Benin is the
only governed country in the ECOWAS sub-region with the best governance indicator. This
suggests an open accountable, transparent form of governance that exists in the country.
However, Nigeria could be said to be the worst governed country in the ECOWAS sub-region.
Thus, it appears that size, political will and strength and high economic growth rate is not a
function of good governance.
3
Theoretical and Empirical Literature
The theoretical theories underlying the relationship between FDI and growth can be classified
into two: the modernization and the dependency theory. The modernization theory is regarded
as the pro FDI which can be classified into neoclassical growth and endogenous growth
theories.
The neoclassical model of growth was first devised by Nobel Prize winning Economist Robert
Solow (1956). The model believes that with a sustained increase in capital investment increases
the growth rate temporarily: because the ratio of capital to labour goes up but the additional
unit of marginal product of additional unit of capital is assumed to decline and the economy
eventually moves back to a long-term growth path, while the real GDP growing at the same rate
as the workforce plus a factor to reflect improving “productivity”.
A “steady-state” growth path is attained when output, capital and labour grow at the same
rate, so output per worker and capital per worker are constant. Neoclassical economists believe
that to raise an economy’s long term trend rate of growth requires an increase in the supply
and an improvement in the productivity of labour and capital. The neoclassical model treats
productivity improvements as an “exogenous” variable meaning that productivity is assumed to
be independent of capital investment.
The endogenous or new growth theory lays more emphasis on human capital as the cause of
economic growth. The theory believes that improvements in productivity can be linked to a
faster pace of innovation and extra investment in human capital.
The theory predicts positive externalities and spill-over effects from development of a high
value-added knowledge economy which is able to develop and maintain a competitive
advantage in growth industries in the global economy. They believe that the rate of
technological progress should not be taken as a given in a growth model. There are potential
increasing returns from higher levels of capital investment. The theory emphasizes that private
investment in R&D is the central source of technical progress. Protection of property rights and
patents can provide the incentive to engage in R&D. investment in human capital (education
and training of the workforce) is an essential ingredient of growth. If all the above stated
conditions are satisfied, it is expected that the economy will b on the growing trend.
The dependency theorist could be termed anti-FDI. They assert that FDI in whatever form will
retard the growth process of the economy and thus called for an end to FDI as it is not
favourable. This can be justified by the work of Rand and Tarp (2002) who found that FDI
inflows are very volatile. In their assessment of the relationship between FDI and output, there
is no general relationship between the two variables. Falki (2009) examined the Impact of FDI
on Economic Growth of Pakistan and who concluded that FDI has negative statistically
insignificant relationship between GDP and FDI inflows in Pakistan. In a similar dimension,
Carkovic and Levine (2002) analyzed the relationship between FDI and Growth by constructing
a panel data set for 72 countries for a period of seven five- year periods between 1960 and
1995. Their study finds that the exogenous component of FDI does not exert a positive, robust
influence on economic growth though it was stated that their result was not a call for an end in
the flow of FDI.
Thus, the unsettled argument in the two camp might have necessitated varying results as
regards the impact of FDI on growth hence, leading to an inconclusive debate on the FDIgrowth nexus.
Good governance would include an effective, impartial and transparent legal system that
protects property and individual rights; public institutions that are stable, credible and honest;
and government policies that favor free and open markets (Chandra and Yokoyama, 2011).
These conditions encourage FDI and presumably private domestic investment as well, by
protecting privately held assets from arbitrary direct or indirect appropriation. Generally, “good
governance” indicators have six dimensions: i) Voice & Accountability, ii) Political Stability and
Lack of Violence/Terrorism, iii) Government Effectiveness, iv) Regulatory Quality, v) Rule of Law,
and vi) Control of Corruption (Kaufmann et al., 1999).
Different organizations have offered dissimilar means of measuring governance and as such this
study will limit its scope to just six indicators: Country Policy and Institutional Assessment
(CPIA); International Country Risk Guide (ICRG); Freedom House indicator; Transparency
International and World Bank (KKZ) governance indicator. It is important to note that
Transparency International limit its definition of governance to just corruption while others
define governance in a broader sense.
Chandra and Yokoyama (2011) contributed to this debate by exploring the role of good
governance in promoting knowledge based indicator (KBI) as the cause of the positive
relationship in the FDI-growth nexus. KBI was measured through the use of Knowledge Index
and Knowledge Economy Index. It was concluded that there is a positive relationship between
good governance and KBI. Thus, it is expected that this will influence the positive impact of FDI
on growth.
Brusse and Griozard (2006) captured governance with government regulations (business and
labour regulations) based their analysis on 84 countries that span through the period of 19942003. It was asserted that governance in also a major determinant of FDI aside from education
attainment level and financial market development as raised by Borensztein et al. (1998) and
Alfaro et al (2000) respectively. The positive impact of FDI on growth is conditioned upon the
fact that “…governments first have to tackle the institutional setting and regulatory framework
in their countries”.
Other studies employ more specific measures of governance. Hellman, Jones and Kaufman
(2002) find that corruption reduces FDI inflows for a sample of transition economies.
Carstensen and Toubal (2003) use a macroeconomic risk ranking found in Euromoney to
estimate a panel data model of the determinants of FDI into Central and Eastern European
countries. The less risky the country by the Euromoney ranking, the more attractive is the
country for FDI.
As sited in Globerman, Shapiro and Tang (2004), a variable related to governance that has also
been identified as an important determinant of FDI is privatization. Holland and Pain (1998)
identify the privatization process as one of the key determinants of the level of direct
investment in the early years of transition. Specifically, for eleven European economies for the
period 1992-1996, they find that indicators of privatization are positively related to levels of
inward FDI. Carstensen and Toubal (2003) also find that the level of privatization plays an
important role in determining the flows of FDI into a sample of Central and Eastern European
countries over the period of the 1990s.
Globerman, Shapiro and Tang (2004) in their work on the determinant of both inward and
outward FDI concluded that the importance of governance on FDI and economic growth
relationship as it is very important in attracting FDI in whatever form. It should also be noted
that outward FDI should not be seen as a cause of poor and/or low level of governance rather
“…as part of a process that promotes international specialization of production and trade with
the associated efficiency gains that economists traditionally associate with economic
specialization”.
Ford, Sen and Wei (2010) considered a disaggregated governance indicator and used china as a
case study for a sample period of 1970 to 2005. Both Two Stage Least Square (TSLS) and
Generalised Method of Moment (GMM) were adopted. The result reached was that all the
disaggregated form of governance is beneficial to economic growth. Trade liberalization and
government expenditure on education are the two government policy that has influence on
FDI. However, it was concluded that even in the face of good governance, FDI has no positive
impact on growth.
Farooque, Yarram and khandaker (2009) based their argument on a sample of 173 countries
and the time frame was from 1996 to 2007 adopted both OLS and TSLS as estimation
technique. The result indicated that both FDI and governance are interdependent i.e. they are
co-deterministic. The same result was reached when there was control for time, region and
income factors.
A possible reason for difference in results by previous researchers could be related the
arguments raised by Blonigen and Wang (2005) who showed importance of controlling for
country-specific effects in cross national studies. In order to take this into consideration, this
study takes cue from the works of Mengistus and Adams (2007) and Nath (2005) by employing
dynamic fixed effects estimation approach to examine the effect of FDI dependence on
economic growth in the selected developing countries.
In sum, there is consensus in the literature about the positive impact of governance on growth.
This means good governance leads to economic growth. However, there are diverse views
about the impact of FDI on growth. The literature on governance, FDI and growth limited which
requires further research.
Figure 1: Conceptual framework of governance, FDI and economic growth
Governance
Growth
FDI inflow
Source: Authors graphical explanations.
The figure above depicts the relationship between Governance, FDI and Growth. The black
arrows show there is a unidirectional relationship between the variables which run from
governance – attraction of FDI inflow – economic growth. This relationship precedes the red
arrows. The red arrows could be term second other condition which shows bi-directional
relationship amongst the relationship.
4
Methodology
It is the objectives of this study to capture both the linear and non-linear (TAR) growth model.
Hence, we begin our analysis with the linear growth model. This paper serves as a follow up to
the works of (Mengistus and Adams, 2007; Nath, 2005; and Hermes and Lensink, 2003 to
mention a few). The empirical analysis is based on a panel data set of 7 ECOWAS member
countries over a period of 15 years (1996 - 2010)
Linear Growth Regression
We estimate a cross-section regression of the form;
𝑌𝑖𝑡= 𝛽0 + 𝛽1 𝑋𝑖𝑡 + 𝛽2 𝑍𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡
(1)
Where Yit is measured by GDP per Capita growth rate, for country i and at time t. X is a vector
variable set that contains trade openness (BOP), Stock of human capital (SCH) and foreign direct
investment (FDI). Z is an additional vector variable set which are considered as determinant of
growth (Barro, 1991) and they include government consumption (GOC), inflation (INF), and
proxy for governance (GOV). μi represent country specific effects which is assumed to be time
invariant and 𝓔it is the error term. The fixed effect specification allows us to control for
unobserved country heterogeneity and the associated omitted bias, a problem that seriously
afflicts cross-sectional country regression (Mengistus and Adams, 2007).
Non-Linear Growth Regression
To the best of our knowledge, no previous studies have captured the threshold effect of
governance on FDI-growth nexus. Hence, we estimate the growth regression of the form;
Yit = αXit +α2 Zit +
β1FDIt + ε1,
GOV ≤ γ
Β2FDIt + ε2, GOV ˃ γ
(2)
Equation 2 can be re-written in the following form;
Y it = β1 FDI it DM (GOV it≤ γ1) + β2 FDI it DM (GOVit > γ2) + θ’ X it + εit + μi
(3)
Where all variables remain has earlier defined with the exception that GOV is no longer a
variable in the Z vector and DM represent Dummy variable which is equal to 1 if GOV> γ or 0 if
otherwise.
GOV serves as sample split in the growth equation. This means once GOV reach the threshold
value, the perceived benefits of FDI on growth will start to manifest. Until then the cause of
economic growth (if any) is not attributed to FDI.
Data Measurement
The choice of our variables was informed by previous studies such as (Borensztein et al, 1998;
Alfaro et al, 2003; Hermes and Lensink, 2003; Blonigen and Wang, 2005 and Mengistus and
Adams, 2007). It is of our view that the variable of interest in this study is FDI and it is measured
as total FDI inflow as a percentage of GDP. As a result of augmenting the low savings rate in the
host country, it is expected that FDI will propel economic growth. Trade openness (export
minus import) which is measured as a percentage of GDP reflects the degree to which an
economy liberalizes its borders with trading partners’. Positive trade openness will lead to
economic growth because it means the country is exporting more than its import of goods and
services.
Human capital is proxied by a percentage of total population. Economic growth and human
capital are positively related because a higher rate of human capital will improve the
productivity level of the host country. Inflation is also measured in percentages and it captures
the macroeconomic stability. Inflation-economic growth nexus exhibit a negative relationship
because higher inflation rate reduces real income and hence, making the economy worse-off.
We include government consumption to determine the level of government involvement in the
economy. It is expected that there is a negative relationship between economic growth and
government consumption. This is because GOC crowds out private participation. It is
conventional in the literature to assess economic growth by the use to GDP. Finally,
governance6 is computed by using the average of the six indicators of KKM. Data sources and
aprioir expectation are presented in the Appendix section.
5
Empirical Result
Linear Growth Equation
We presented our growth regression in the appendix section as indicated in Table 2. FDI is
positively related to GDP in both OLS and Fixed- effects estimation with 5 and 10% level of
significance respectively. We included the lagged value of both FDI and GDP in order to capture
the dynamic effect of the. The result of the dynamic effects confirms the positive relationship in
the FDI and growth nexus which is both significant at 5% level of significance.
Table 5.1: Linear Equation Regression Result
Variables
OLS
FIXED EFFECT
NORMAL EFFECT
DYNAMIC EFFECT
NORMAL EFFECT
DYNAMIC EFFECT
FDI
0.2531*
-0.6779
0.0038**
-0.6458
INF
-0.0376*
0.0537
-0.0909**
0.0198*
GOC
0.5913*
0.2800
0.3918
0.0358**
BOP
0.2496**
0.0179*
0.2935
0.0259*
GOV
2.9984*
0.3185**
6.0699
-0.2471
FDTt-1
0.9317*
0.9572*
GDPt-1
0.439**
0.4366**
R2
0.1441
0.3295
0.1606
0.3472
DW
1.104
2.2863
1.1755
2.3577
6
The governance index we use was first developed by Kaufmann, Kraay, and Zoido-Lobaton (1999a and 1999b), and recently
expanded upon and updated by Kaufmann, Kraay and Mastruzzi (2003). They estimate six separate indices (which we will refer
to as KKM indices) including measures of political instability, rule of law, graft, regulatory burden, voice and political freedom,
and government effectiveness. The indices have been estimated (using an unobserved components model) employing 31
different qualitative indicators from 13 different sources, including BERI, DRI/McGraw Hill, the Heritage Foundation, the World
Bank, the World Economic Forum and the Economist Intelligence Unit. The indices are highly correlated with each other such
that it is very difficult to use them all in a single equation (Globerman, Tang and Shapiro, 2004). We measure it by finding the
average of the fist component (estimate) of the six indicators created by KKM. This is in contrast to how Globerman, Tang and
Shapiro (2004) who aggregated the indicators. If this is done in for the selected countries, it would be found that the aggregate
would exceed the range (-2.5 to 2.5) used by Kauffman et al as measuring yardstick.
The result confirms the apriori expectation of the negative relationship between INF and
economic growth in both OLS and fixed-effects estimation which is significant at 5%. This
confirms the results of Romer and Romer (1998). Government consumption is positively related
and significant to growth in our OLS estimation. However, this ceases to be the case for fixedeffects estimation and result obtained was not significant. This negates the assertion of Barro
(1991) who opined that increase in government consumption is related to decline in the rate of
economic growth.
The effect of trade openness on growth is positive and mostly statistically significant. Thus, a
favourable the balance of payment enhances the growth process. The effect of governance on
economic growth is positive and significant for our OLS estimation. This confirms the assertion
of (Chandra and Yokoyama, 2011; Ndulu and O’Connell, 1999; Rodrik, 2006) who all stated
institution plays a major role in the growth process of a country because it ensures formation of
property rights and efficient allocation of resources. In addition, North (1996) affirm that “…it
may indeed be the single most important determinant of economic performance after
capturing for efficient markets”.
Non-Linear Growth Equation
For this section, our estimation is based solely on OLS as we neglect Fixed and dynamic-effects.
A repeated estimation of equation 3 was done using different values for our sample split, it was
found that the threshold level of governance for the positive relationship in the FDI-growth
nexus is about -1.2. Until this threshold is achieved, governance has no role to play in the nexus.
When the significance test proposed by Hansen (2000) was carried out, the Likelihood Ratio
obtained was 3.3263 which then led us to state that the threshold value of governance is not
statistically significant at 1% and 5% in Hansen’s Asymptotic Critical Value. The reason(s) for this
is hard to explain. Thus, this is a cause for future research. This result is presented in table 3 in
the appendix section.
Table 5.2:
Variable
Non-Linear Equation Regression Result
Coefficients
S.E
T Stat
fdi*(gov<-1.2)
6.433174
1.121624
5.735589
fdi*(gov>-1.2)
-0.15322
0.477989
-0.32055
inf
0.018048
0.048276
0.373843 LR Value
goc
0.868842
0.267627
3.246468 R-squared
0.626128
gov
0.886712
1.375348
0.644718 Sum squared resid
524.3167
bop
0.207706
0.077401
2.683515
6
3.3263
Conclusion
This study examines the triplex issue of FDI, Governance and Economic Growth in seven
ECOWAS Countries from 1996 -2010. Our linear equation result confirms positive impact of FDI
and Governance on economic growth process. Thus, it should be emphasized that policy
makers should formulate policies that is not limited to attracting FDI but also those that are
could improve governance in the country. Trade openness and government consumption follow
the expected impact and are significant. Our TAR result estimated a threshold value for
governance to be -1.2 though, this is not statistically significant at the 5% level.
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APPENDIX
Table 1
Variables, Symbols, Sign and Sources of Data Collection
Variable
Symbol
Sign
Source of Data
Economic Growth
GDP
+
World Development Indicator
Foreign Direct
Investment
FDI
+
World Development Indicator
Trade Openness
BOP
+
United Nations Conference on Trade And
Development
Government
Consumption
GOC
-
World Development Indicator
Governance
GOV
+
www.govindicator.org
Inflation
INF
-
World Development Indicator