Effect of infrastructure on FDI behaviour in Kenya: a Growth Nexus Analysis

Abstract

This study investigates the effect of infrastructure on foreign direct investment (FDI) in Kenya. The study further investigates the effects of FDI on economic growth in Kenya. The study’s objectives lead to the examination of the nexus between FDI, infrastructure and economic growth in Kenya over the period 1970-2019. In the study, both FDI and economic growth are analysed with either infrastructure composite index (INFR), transport infrastructure, energy infrastructure, ICT infrastructure, or water infrastructure. INFR composite index is generated through the principal composite analysis to estimate a system effect of the individual models. Control variables are included in the models. The control variables consist of some of the key determinants of FDI inflows and which also determine economic growth including market openness, inflation rate, exchange rate, financial development and labour resources. The study variables are first tested for unit root using Augmented Dickey-Fuller (ADF); Phillips Perron (PP); and Kwiatkowski, Phillips, Schmidt and Shin (KPSS) tests. The unit root results indicate that the variables of the study are a mixture of I (0) and I (1). Hence Autoregressive Distributed Lag (ARDL) Bounds approach is best suited to determine the cointegration of the variables and the long-run relationships. Where cointegration exists, error correction analysis is carried out to determine the long-run dynamics and the short-run causal effects. When there is no cointegration, a short-run analysis is carried out to determine the short-run causal effects. Granger causality test is finally undertaken to test the study's null hypotheses. The diagnostic tests of the time series models are carried out at every appropriate stage. The ARDL bounds test results reveal that FDI, infrastructure and economic growth are cointegrated. The Granger causality tests confirm that infrastructure Granger causes FDI, FDI Granger causes infrastructure development, infrastructure Granger causes economic growth, and economic growth Granger causes infrastructure development. Therefore, a bi-directional relationship can be said to exist between FDI and infrastructure development, and between economic growth and infrastructure development. The study results find that the hypotheses that economic growth Granger causes FDI, and FDI Granger causes economic growth are not supported by data for Kenya. The long-run and short-run regression analyses results show that infrastructure (composite index) has a statistically significant positive effect on FDI both in the long and short-run. Transport infrastructure significantly and positively influences FDI in the long-run and economic growth in the short-run. Water infrastructure has a significant positive effect on FDI in the long-run. The ICT infrastructure has a significant negative effect on FDI in the short-run and a significant positive net effect on economic growth. FDI has a significant positive effect on water infrastructure in the short-run. Economic growth has a positive effect on infrastructure (composite index) and water infrastructure in the short-run. The study results imply that a meaningful inflow of FDI into Kenya is contingent on infrastructure development. Government of Kenya policies should revolve around increasing infrastructure investment, especially in transport and water. Investment in ICT (telephony connections) might not be useful in attracting FDI. A conducive environment should be created to encourage inflows of FDI and growth of the economy, both of which have a causal effect on infrastructure development. The policies intended to improve FDI inflows, economic growth and infrastructure development may require to be augmented with complementary policy initiatives that would include opening the market, macroeconomic stability, improving human resources and institutional development.