In examining this existing body of research on foreign direct investment in developing countries, this literature review aims to amalgamate, key fin

Literature review

In examining this existing body of research on foreign direct investment in developing countries, this literature review aims to amalgamate, key findings within the subject, identify prevalent trends and to overall explore the factors that affect FDI inflows across multiple nations. There are multiple key terms, however it is important to understand the key concept as to what FDI is. At its core FDI can be defined as a category of cross-border investments by which an investor in one economy chooses to establish a lasting interest and degree of influence over an enterprise resident in another country (OCED ilibary). The OCED further in their definition discuss that an enterprise resident must hold 10% or more of the voting power in one economy by an investor in another economy. Into the bargain, the metadata glossary provided by the world bank provide a different scope. In economics terms, the world bank believe that FDI represents a net inflows of investment necessary for acquiring a lasting management interest whereby 10% or more of the voting stock in an enterprise operating in another economy which is separate from the investor. Both of these definitions can be seen as pivotal ways of understanding how FDI is broken down. Whilst the two definitions are similar, there are differences between the two. One may argue that the world bank definition provides a more realistic and intentional definition as they measure FDIs true impact in the relationship between the enterprises and their investors. The definition also provides how it is calculated as well as providing insight into the net flows and calculating short-term capital. The OCED on the other hand place further intent on the word lasting interest highlighting that there is a position of control within FDI as well as a long-term existence of a relationship and management between them and the latter (Duce 2003).

Within the subject of FDI one may consider other types of definitions to understand this topic more deeply. In a similar vein, FDI inflows can be defined as transactions that have increased from investments from foreign investors in resident enterprises, it is argued that FDI flows are always measured in USD as a share of GDP. Alternatively, They define outward FDI as measuring FDI investments through the lens of domestic companies within a foreign economy. Whilst alternatively inward FDI measures the investment made in a country to another country. For the purpose of this thesis, we will focus on the inward FDI

Let us now move on to discuss the key themes and concepts that come from the chosen topic. The study of Foreign Direct Investment, circumscribes several key themes. These very themes are necessary for deepening our understanding of FDI. The first chosen theme discussed will be reasons for country engaging in FDI. Multiple authors and articles have all come in unison to agree that there is a necessity for countries to engage in FDI. FDI provides lucrative and valuable opportunities for countries to tap into new markets. As well as traditionally being a principal mechanism in bringing together national economies hence it becoming an international economy (Kok and Ersoy 2009). They then further discuss that engaging in FDI also allows for increased access to natural resources which are pivotal in developing a countries economy.

One can argue that foreign direct investment is a large factor that represents long term interests from foreign entities within a host countrys business within the management of a country or an enterprise which does involve the technology transfer and expertise of capital flows (OCED). FDI plays a vital role in economic growth, creating jobs which then aids in decreasing unemployment (Lipsey 2001) as well as enhancing productivity through the introduction of new technology and skills. It serves as a critical source of external finance for developing countries. This being done through offering potentially focusing on the avenue of economic integration and diversification into the global economy.

Theoretical Framework

Despite the extensive research undertaken on foreign direct investment, it is easy to find several research gaps, which include the mark of the digital transformation and the necessity for sustainability. An author who aimed to diminish these gaps goes by Dunning (1980). Dunnings OLI paradigm presents a profound understanding of foreign direct investment by meshing the need for ownership, location and internalisation into a complete model. This model uses many decisions that are necessary for business or in this case world leaders to determine the right business decision.

The acronym presented by Dunning (1980) stands for:

Ownership Advantage: Whereby certain assets or capabilities a country has that can give it a competitive edge within another market. These can include branding, trademark or patent rights. These factors are almost usually intangible which gives a country a competitive edge. For example the Democratic Republic of Congo having a competitive edge in raw materials.

Location advantage: This area refers to benefits of operating within a certain proximity zone. As well as having access to major markets or access to materials that can benefit ones nation greatly. And finally the regulatory conditions of where a nation is can also be favourable

Internalisation advantage: This area focuses on the reasoning behind why a company or a country would rather better produce a particular product in house or have to do their production externally. Reason being as the foreign company or country may be better at producing a particular product that is needed. This in turn will allow for transaction costs to decrease.

Dunning presented this paradigm to diminish the existing gap of work proposed by the Buckley and Casson (1976). They discussed that through internalisation firms are able to reduce the transaction costs that are associated with market failure. They further discussed that by internalising their operations within a foreign market, it consequently means that they can control and manage their resources more efficiently. Whilst allowing themselves to protect and to put to better use their competitive advantages. Dunnings theory managed to put to bed the limitations of Buckley and Cassons theory through discussing the fact they did not fully include other factors that may influence a firms decision to invest in another nation.

Dunning OLI Paradigm Dunning OLI (Ownership, Location, and Internalization advantages) paradigm is crucial to understanding the strategies and motivation behind FDI in the context of developing countries like Africa. As per Sharmiladevi (2017), this paradigm helps understand why FDI is important for firms in comparison to licensing or exporting. The firms need to possess specific advantages in three domains. Firstly, ownership advantages where specific assets of firms like brand reputation, technology, and managerial expertise can provide a competitive edge in the local area. Secondly, location advantages like government policies, cost of labor, and market size make a country attractive from an investment perspective (Sharmiladevi, 2017)

Thirdly, internalization advantages take the lead when a firm prefers to control its operations in foreign land directly rather than opting for modes like licensing or exporting to keep transaction costs low and safeguard its proprietary knowledge. According to Batschauer da Cruz et al (2022) OLI Paradigm can also be applied at a sub-national level where FDI decisions can be influenced by differences at the regional level for instance labor, infrastructure, and local policies as they vary substantially within a country boundary. On the other hand Wilson and Baack (2012) believed that FDI advertising strategies need to be integrated with the OLI Paradigm. This is due to the fact that merely locations attractiveness will not add value. There is a need to communicate the same to the potential investors who have the ability to perceive the advantages. This helps to introduce and implement the aspect of marketing and the importance of discussed perception in the OLI Paradigm. Kida (2014) argued that OLI framework is not enough to capture the complexities in FDI as a wholesome approach in context to developing economies like Africa. It did not consider the factors like corruption, inadequate legal frameworks, political instability due to which traditional or local advantages were overshadowed which were identified by Dunning in the suggested framework earlier (Asiedu, 2005). As a result it becomes crucial for firms to invite FDIs and opt for preferential treatments given by governments thus influencing regulations at local levels.

FDI in Africa: Trends and Challenges There had been significant fluctuations noted in the FDI segment over the past two decades highlighting challenges and trends that were persistent and promising respectively at the same time. While analyzing historical trends a steady increase has been observed in resource-rich countries like Africa. As per Ajayi (2006) from 2004 FDI increased in sectors like oil and gas, mining, etc. due to the global commodity boom. This resulted in significant investments marked by FDI resulting in economic growth as an influx of capital led to the development of a job market, infrastructure, and technological upgrades. However, Jaiblai and Shenai (2019) argued that over-reliance on FDI in the case of extractive industries has made the African economy vulnerable to global volatile fluctuations by increasing their dependence on volatile commodity prices. Jaiblai and Shenai (2019) also pointed out that African GDP was positively impacted by FDI while on the other hand, it was exposed to external shocks like the global financial crisis of 2008. This raised questions about the sustainability of the economic growth fostered by FDI. Africa is a country that has shown tremendous growth in manufacturing, technology, and service sectors in the last decade as compared to countries where better infrastructure and a stable political environment exist. Zekarias (2016) indicated that FDI in eastern Africa positively impacted sectors like telecommunications, retail, and banking. By ensuring regional integration through diversified economies and the development of new markets for Made in Africa products economic growth has been fostered consistently (Zekarias, 2016.). Despite opportunities Cleeve (2012) mentioned that attracting and retaining FDI in Africa i

Moving forward let us now answer one of the key objectives of this thesis is to uncover the understand the determinants of FDI and understand the effects that they have on FDI growth. There are multiple determinants of FDI, those can be seen as political, economical as well as the social factors. The factors of FDI are driven by factors that can come under economic conditions, market potential and the regulatory environment which all crucially change the FDI flow (Busse and Hefeker 2007). The first factors that will be discussed will be economic factors.

Economic factors

The role of economic factors has a crucial cog and influence over FDI. Reason being because it affects how well a nation will do, the opportunities within another market and how well the investments in another country will be. Investors are often attracted to countries with stable economic conditions as well as favourable regulatory conditions, with the inclusion of robust infrastructure, political instability, poor governance and inadequate infrastructure are all factors which can deter foreign direct investment. In the context of developing regions such as Africa. Historically been concentrated in natural resource extraction. However, recent trends have indicated a shift towards diversified investment including telecommunication, financial and manufacturing sector (Sauvant and Mallampally 1999). By which the transfer of technology between countries will also become enhanced. Which then promotes international trade through their access to foreign markets. Which can also be seen as a crucial driver for economic growth.

In the same manner one could interject that although most nations may have the opportunity to grow. FDI is widely seen as one of the biggest and widest sources of investment, technology, transfer and growth (Iamsiraroj 2015). Although in the same sense one could argue that for larger nations it is easier for them to benefit from investing. (Iamsiraroj 2015) discusses how although the countries smaller nations face the huge advantage of having an abundance of natural resources, they do in turn face the conundrum of having limited human resources. Highlighting the differences a fully equipped nation and emerging nation continents such as Africa.

For policy makers it is integral that policymakers are able to understand and be able to create and maintain FDI. Which will as a result foster economic development into the global economy.

Institutional quality and Governance

High institutional quality can be deemed as a fundamental reason for FDI, as it has a large influence upon home investors as well as foreign investors. Institutional quality can be typically defined as the absence of corruption, whilst being able to respect the property rights as well as the rule of law in place (Du and Zhang 2018). Whilst their definition of institutional quality is clear and concise the definition fails to account for the informal institutions such as cultural values and the way in which society behaves.

Within institutional quality, there are six indicators of institutional quality proposed by multiple sources and governing bodies. They are known as:

Voice and accountability

Political stability

Government effectiveness

Regulatory Quality

Rule of Law

Control of Corruption

For a country a country to have high institutional quality it is important that they have certain characteristics such as transparent and accountable institutions which who put into action the rules and regulations (Acemoglu and Robinson 2012) . Dunning (2000) discussed that positive governance and economic freedom are increasingly becoming popular determinants of FDI for multinational companies. This can be as result of good governance ensuring that there is stable political people in power as well as also having a stable economic environment meaning that those who want to partake in FDI can also plan and operate more effectively. It also stands to reason that among developing countries there is poor quality governance which is also couples with low investment (Jude and Levieage 2013). They discussed that weak institutions causes higher costs which may also decrease the attractiveness of investing. However, there may be heavy amount of attention on the fact that they believe that the quality of governance can be seen as the main factor of FDI. In addition, they ignore and fail to acknowledge economic stability and the cost of labour.

This is also highlighted with the corruption perception index (Figure 1) displaying the fact that entirety of Africa is basically corrupt. Reason as to why this then affects FDI is because there is a standpoint of weak legal protection North (1990), discussed that institutions are supposed to have formulated so that there is a reduction in the uncertainty of human exchange. With corruption being in place there is space for an unpredictable business environment. Unpredictability will stop investors who prefer transparent and stable conditions. This is supported by Peng (2001), who argues that because networks and relationship-based tactics are widely used in areas where formal institutions are weak, greenfield investors may find it more difficult to integrate into local business networks.

Within the chosen topic, multiple articles and authors have all come together in unison to agree that FDI is an integral part of for countries business operations. This can be due to several factors. Firstly, the fact that there will be an influx of economic growth, which is able to then stimulate capital, which can then therefore be used to create jobs, which then as a result means that managerial skills can be accessed which then increase the number of industries that are being developed in a nation (Kariuki 2015).

Economic factors have a significant effect on FDI as they have a direct influence on how profitable or whether it is risky for a country to expand operations in a foreign market. Since the early conception of foreign direct investment is deeply rooted in economics (Kurtishi-Kashtrati 2013). Whilst Hymer was credited with the theory of FDI in 1960 but not published till 1975. Ricardos theory of comparative advantage did mean that should there be less protection of a product then resources would have to opt for a different approach of using high-cost methods to low-cost methods. Which aimed at looking at real costs in terms of different types of commodities (Siddiqui 2017). Furthermore Hecksher-Ohlin (1933) also attempted to extend the pillar of FDI through using the endowment theory, assuming that countries will also aim to use their ample number of resources and relatively cheap factors of production to utilise a countrys limited resources. However, one of the main problems with the two theories spoken is that whilst Ricardo tried to apply FDI to comparative advantage Kurtishi-Kashstrati (2013) singled out a limitation being that comparative advantage only applies when there are two countries against each other, as well two products as well as the mobility too. Furthermore, Ricardos model failed to account for the fact that there can be differences in factor endowments meaning that FDI is unable to merge with FDI. Highlighting how such a model is unable to be used for FDI as it fails to account for the dynamic aspects of FDI.

GDPs

For investors, GDP is one of the biggest influencers that can affect a business decision. GDP can be seen as way for investors to measure a countrys market size as well as their potential profitability. In certain regions it goes without saying that there has been an increase in the amount of buyers that are being found in host countries. Coupled with the fact that for large African nations, economic growth and a large population seem like a definite incentive for foreign countries to then invest in (Karuiki 2015). Borensztein, Gregorio and Lee (1998), studied the effect of FDI on economic growth and concluded that there is indeed a relationship between FDI and human capital, using a cross country regression. They discussed that the link between the two factors are complementary and that that the reason for any sort of economic growth is because of the interactions of with the human capital of a host country. A proposed limitation of this study is that since the study is cross-country based, it as a result means that it fails to attain any results that would be country specific. Moreover, their study solely focused on human capital, whilst completely omitting other factors such as institutional quality.

In unison Blomstrom and Kokko (2003), explored the relationship between FDI and economic growth the same with Borensztein et.al.(1998). However, whilst they both agree that FDI can be seen as a positive mechanism, as FDI can bring capital and an increase in technology, as well as skilled employees which can in turn drive and increase development. Blomstrom and Kokko (2003) acknowledged that the transfer of technology is not only done through machines but also through the training of the local employees. As a result of them being trained and increasing their knowledge. On the other hand Lall (2002) takes a different scope in arguing that focusing solely on human capital is an error and that it is more beneficial that countries need to attain better technology in order to take advantage of FDI.

Inflation

Udoh and Egwaikhide (2008) explored the relationship between inflation and FDI stating that uncertainty about inflation reduced the inflow of FDI. This reduces the chances of earning profit due to instability in the country resulting in loss of long-term investments. On the contrary, Asiedu (2005) mentioned that economic growth factors and market size can contribute to balancing the negative effects of inflation. It can be said that robust economic policies can help in controlling inflation and the FDI environment can be converted into a favourable aspect. Besides the above demand-pull inflation is also responsible for inviting FDIs in the country. When demand is more than supply it indicates market expansion is possible and hence investing is profitable. While cost-push inflation indicates that production cost is high, and profit margins will be lower thus distracting FDIs. These aspects are also crucial for foreign investors before deciding on their investment moves.

Exchange Rates

In the context of the Africa nation Nigeria Omankhanlen (2011) examined the relation between FDI and exchange rates. Investors are usually considerate about the valuation of the currency and as a result, instability in the exchange rate makes them hesitant towards long-term projects due to erosion of profits. Nyarko et al (2011) presented a contrast stating that exchange rate regimes are responsible for FDI inflows. For instance, in Ghana, banks followed a managed float regime where the central bank intervened for the stabilization of the currency and contributed to the mitigation of volatility related to exchange rates. This is an indication that authorities who manage currency status are also responsible for attracting FDI in the country. Apart from the above, misalignments in exchange rates result in overvaluation or undervaluation of currency which leads to distortion of investment decisions regarding FDI. Overvaluation is responsible for making the exports less competitive thus reducing opportunities for attracting FDI in export-oriented industries (Nyarko et al. 2011). Conversely, undervaluation shows potential to attract FDI as it indicates the availability of cheap labor and low cost of production while showing high risk towards correction leading to uncertainty. This aspect is required to be explored in detail to understand the perspective in a broad spectrum for varied economic contexts (Cleeve, 2012).

FDI in Africa: Trends and Challenges

There had been significant fluctuations noted in the FDI segment over the past two decades highlighting challenges and trends that were persistent and promising respectively at the same time. While analyzing historical trends a steady increase has been observed in resource-rich countries like Africa. As per Ajayi (2006) from 2004 FDI increased in sectors like oil and gas, mining, etc. due to the global commodity boom. This resulted in significant investments marked by FDI resulting in economic growth as an influx of capital led to the development of a job market, infrastructure, and technological upgrades. However, Jaiblai and Shenai (2019) argued that over-reliance on FDI in the case of extractive industries has made the African economy vulnerable to global volatile fluctuations by increasing their dependence on volatile commodity prices. Jaiblai and Shenai (2019) also pointed out that African GDP was positively impacted by FDI while on the other hand, it was exposed to external shocks like the global financial crisis of 2008. This raised questions about the sustainability of the economic growth fostered by FDI. Africa is a country that has shown tremendous growth in manufacturing, technology, and service sectors in the last decade as compared to countries where better infrastructure and a stable political environment exist. Zekarias (2016) indicated that FDI in eastern Africa positively impacted sectors like telecommunications, retail, and banking. By ensuring regional integration through diversified economies and the development of new markets for Made in Africa products economic growth has been fostered consistently (Zekarias, 2016.). Despite opportunities Cleeve (2012) mentioned that attracting and retaining FDI in Africa in constitutional impediments which has created barriers for the smooth inflow of FDI in Africa. This has given the signal of high risk for investment and warned foreign investors from proceeding ahead for same.

Hypothesis creation

This section will discuss the following hypotheses:

FDI and Economic growth: we propose, that increased FDI has a connection with increased economic growth in countries that are still developing. As a result of technology and recently developed capital (Rodrik 2011). Hence predicting that increase in FDI will cause an increase in economic growth.

FDI and Exchange rate: we propose that, countries with a weaker local currency will attract more FDI, as long as the currency itself remains steady. As lower currency will bring about more FDI (Frankel 1998).

FDI and inflation: As discussed above, we found that instability within the economy has a negative effect on FDI (IMF). So we propose that higher inflation rates negatively correlate with FDI inflows.

FDI and Institutional Quality: Having discussed already, we agree that countries with greater political stability and institutional quality will experience and attract better FDI inflows. Reason being, that better governance ,higher quality legal systems and whether the level of corruption can be controlled to a good enough standard Barro (1997).

FDI and Market size: we hypothesise that larger market are more likely to attract more FDI. Reason being that larger markets possess higher potential in terms investors as well as increase the chance of a higher return on investment (World Investment report 2013).