Effect of foreign direct investment inflows on economic growth : sectoral analysis of South Africa

Abstract

A number of developing countries have been on a quest to attract foreign direct investment (FDI) with the intention of increasing capital inflow through technological spillovers and transfer of managerial skills. FDI can increase economic growth and development of a country by creating employment, and by doing so, increasing economic activity that will lead to economic growth. South Africa is one of the economies that strive to attract more FDI inflows into the country to be able to improve its economy, and the country has adopted policies that drive the motive to attract FDI inflows. This study investigated the effect of FDI on sectoral growth over the period 1970–2014. The purpose was to find out where in the three key sectors of South Africa FDI is more significant. The review of theoretical and empirical literature on FDI revealed that FDI has a diverse effect on economic growth, both in developed and developing countries. Theoretical literature analysed the behaviour of multinational firms and the motive behind multinationals investing in foreign countries. According to Dunning (1993), firms have four motives to decide to produce abroad, namely natural resource-seeking, market-seeking, efficiency-seeking and strategic asset-seeking. Empirical studies on sectors show that FDI inflows affect different sectors in different ways, and that the agricultural sector does not usually gain from FDI inflows, whereas subsectors in the industry and services sector grow from receiving FDI inflows. Sectoral analysis revealed that the services sector receives more FDI inflows, when compared to the agriculture and industry sector. The study followed an econometric analysis technique to test the effect of FDI inflows on the agriculture, industry and services sectors. The augmented Dickey–Fuller and Phillips–Perron tests were used to test for unit root. Both tests revealed that variables were not stationary at level, but that they become stationary at first difference. Vector autoregressive (VAR) models were estimated, and four types of diagnostic tests were performed on them to check the fitness of the models. The tests showed that residuals of the estimated VARs were robust and well behaved. The Johansen cointegration test suggested there is cointegration and that there is a long-run relationship between variables. Following the existence of cointegration, the estimated Vector error correction model (VECM) results showed that FDI has a significant effect on the services and industry sector, but has a negative effect on the agricultural sector. Impulse response analysis results revealed the correct signs, and confirmed the VECM results. FDI inflows explain a small percentage of growth in agriculture and industry, but a sizable and significant percentage in the services sector.