The nexus between official development assistance, foreign direct investment and economic growth in selected African countries

Abstract

Government alone cannot fund all national projects from its limited financial resources. Oftentimes, capital has to be drawn from other sources, both domestically and externally. Domestically, funds can be raised from private investors through the local financial markets, and these can be directed at productive sectors of the economy. Where domestic financial markets are adequately developed, supported by strong institutional quality to a country is able to attract inward international capital flows in the form of foreign direct investment (FDI) and foreign portfolio investment (FPI). However, there are situations wherein a developing country turns to other official flows to provide relief funds such as official development assistance (ODA), which do not need to be repaid. While seemingly good for the government, some scholars argued that ODA creates dependency, which tends to retard economic growth. Africa is losing a substantial amount of ODA and other official flows, partially due to donor fatigue and domestic government policies and actions that shun such funds. This problem has also been aggravated by the global financial crises of the past decade, which saw a significant reduction in FDI capital flows, thus placing increased pressure on ODA. The current study aims to explore the relationship between official development assistance (ODA), foreign direct investment (FDI) and economic growth in selected African countries using annual data from 1990 to 2018. Multiple econometric methodologies are applied to address the research objectives herein. These include the two-step Generalised Method of Moments (GMM), Autoregressive Distributed Lag Model (ARDL), and threshold analysis approaches. Specifically, the current study seeks to confirm the key determinants of ODA and FDI, respectively. The empirical evidence reveals that economic growth, foreign portfolio investment, population growth, trade openness, domestic investment, human capital development, consumer price index (CPI), natural resources and government consumption are the key ODA and FDI determinants into African countries. ODA, population growth, trade openness, domestic investment, and CPI were found to have a positive and significant impact on FDI, while human capital development yielded a weak positive influence on FDI. Economic growth, foreign portfolio investment, natural resources and government consumption exert a negative impact on FDI. Moreover, FDI, population growth, domestic investment, consumer price index, natural resources and government consumption had a positive effect on ODA, while economic growth, foreign portfolio investment, human capital development and trade openness reveal negative effects on ODA. This study furthers assesses the direction and robustness of causality between ODA, FDI, and economic growth in selected African countries, by employing the Dumitrescu-Hurlin Causality test. It emerged that there is no causal relationship between FDI and economic growth, as well as ODA and FDI. We did however find bi-directional causality between ODA and economic growth for the African countries under review. Moreover, the current study examines ODA, FDI and economic growth long-term relationships in selected African countries. It emerged that a negative and significant association exists between FDI and ODA, while there is a positive and significant relationship between FDI and economic growth in the long run. Lastly, taking into account threshold levels - the current study unearthed a positive coefficient of 0.0620 which indicates a favourable link between FDI and economic growth. On the other hand, the negative coefficient of 0.0683 indicates a negative link between ODA and economic growth.