Impact Analysis of foreign Direct Investment on Economic Growth in Ghana by Abubakari Zakari

IMPACT ANALYSIS OF FOREIGN DIRECT INVESTMENT (FDI) ON ECONOMIC GROWTH IN GHANA

ABUBAKARI ZAKARI (Consultant on Trade and Industrial Policy, Private Sector Development and MSEs)

ADDRESS: P. O. Box AT1364 Achimota, Accra Tel: +233 244796541 E-mail: zack792003@yahoo.co.uk

DECEMBER, 2011

DECLARATION I, Abubakari Zakari, hereby declare that this study is entirely my research work effort, and except for references to other researches (published and unpublished) which have been duly acknowledged in this study.

ABSTRACT The impact of FDI on the Ghana may be varied, though itâ&#x20AC;&#x2122;s positive contributions cannot be over emphasized, the countryâ&#x20AC;&#x2122;s ability to take advantage of all the benefits of FDI depends on the openness of the country, business environment, political and economic stability and a host of other factors. The role played by FDI in developing countries has been an attractive subject for many theoretical and empirical studies. A number of factors that are associated with the performance of the economy in terms of GDP include the existence of macroeconomic stability such as the stability of the exchange rate, low interest rate, low inflation. The problem is that it is uncertain whether FDI actual increase economic growth in Ghana and based on this, the question as to whether massive inflow of foreign direct investment into Ghana had a positive impact on growth in Ghana needs to be investigate. The broad objective of this study was to examine the impact of FDI on Economic Growth in Ghana using data from 1970-2010. The trend of the inflow of FDI revealed that the average FDI inflow over the period from 1970 to 2010 was US$232.94 million. The trend generally shows increase in FDI over the years. The trends of economic growth rate from 1970 to 2010 shows that the economy suffered in the 1970s and mid 1980s with more fluctuations and became relatively stable from 1985 and continued with positive GDP rates up to 2010. The variables of the model appear to share a long-run equilibrium relationship. So that, over long period of time the variables will not move independently of each other but rather are linked in the long-run. The regression result indicates that a percentage increase in the annual exchange rate would increase economic growth by smaller percentage at 0.008%. A percentage increase in the annual inflation rate, ratio of FDI to GDP and openness would increase economic growth by 4.8%, 1353% and 354% respectively. A unit contribution of FDI would increase investment which in turns increases GDP and thus leads to higher economic growth. The Granger causality tests show degree of association between foreign direct investment and economic growth in Ghana. The FDI has a greater impact on the economic growth. iii

TABLE OF CONTENTS CONTENTS

PAGE

DECLARATION …………………………………………………………………….

ABSTRACT ………………………………………………………………………..

TABLES OF CONTENTS...........................................................................................

LIST OF TABLES ……………………………………………………………………

vii

LIST OF FIGURES …………………………………………………………………..

viii

LIST OF ABBREVIATIONS AND ACRONYMS

CHAPTER ONE ……………………………………………………………………..

INTRODUCTION ……………………………………………………………………

1.1 Background …………… ……………………………….…………………………

1.2 Statement of problems ………….. ………………………..……………………..

1.3 Objectives of the study ..................…..………………...…………………………

1.4 Research hypothesis .................................................................................................

1.5 Relevance of the Study .........................…………………………….…………….

1.6 Organisation of Dissertation ………………………………………………………

CHAPTER TWO ………………………………………………………………….

OVERVIEW OF GHANA’S ECONOMY AND FDI ……………………………...

2.1 Introduction ……………………………………………………………………..

2.2 Review of trends of FDI in Ghana ..……………………………………………

2.3 Determinants of FDI in Ghana .....………………………………………………

2.4 Contribution of FDI in the Ghanaian economy ...……………………………….

2.5 Challenges of FDI in Ghana .........................……………………………………

20 iv

2.6 The regulatory framework ..........………………………………………………….

2.7 Conclusion .....................................………………………………………………

CHAPTER THREE ……………………………………………………………….

LITERATURE REVIEW ……………………………………….……………………

3.1 Introduction ………………………………………………………………………

3.2 Theoretical Literature ...........……………………………………………………..

3.2.1Theory of FDI .................................................................................................…..

3.2.2 Relationship between FDI and economic growth................................................

3.2.3 Impact of FDI on economic growth....................................................................

3.3 The empirical Literature ..............................................................…………………

3.4 Concluding Remarks on Literature Reviewed ……………………………………

CHAPTER FOUR ………………………………………………………………….

METHODOLOGY AND ANALYSIS OF FINDINGS .................................…….. ..

4.1 Introduction ………………………………………………………………………

4.2 Method of Analysis and Theoretical Framework for the model specification.......

4.2.1 Method of Analysis .................................……………………………………….

4.2.2 Theoretical Framework............................................................................................

4.2.3 Model Specification ………………………………………………………………

4.3 Data Sources and Description of Variables ……………………………………….

4.4 Descriptive Statistics of the Variables …………………………………………...

4.5 Trend of FDI ..........................................................................................................

4.6 Trends of Economic Growth ...……………………………………………………

4.7 The time series properties of the variables ……………………………………….

4.7.1 Unit root test ……………………………………………………………………

52 v

4.7.2 Co-integration test ………………………………………………………………

4.8 Analysis of findings of regression results ………...................................................

4.8.1 Long Run Growth relationship of Cointegration Equation..................................

4.8.2 Vector Error Correction Model (VECM)..............................................................

4.9 Causality test between FDI and Economic Growth................................................

CHAPTER FIVE …………………………………………………………………….

SUMMARY, CONCLUSION AND POLICY RECOMMENDATIONS....................

5.1 Summary and Conclusion...…………………………………………………………

5.2 Policy recommendations ……………………………………..................................

REFERENCES .............................................................................................................

LIST OF TABLES Table 4.1: Summary of statistics......................................................................................

Table 4.2: Result of ADF Unit Root Test of variables at their levels..............................

Table 4.3: Result of ADF Unit Root Test of variables at their difference......................

Table 4.4: Results of Philip-Perron Unit Root Test of variables at their levels...............

Table 4.5: Results of Philip-Perron Unit Root Test of variables at their difference.......

Table 4.6: Results of Johansen co-integration test..........................................................

Table 4.7: Results of the long-run Coefficients of Cointegration Equation....................

Table 4.8: Results of Vector Error Correction Model (VECM)......................................

Table 4.9: Results of Pairwise Granger Causality Tests................................................

vii

LIST OF FIGURES

Figure 4.1: Trends of FDI from 1970 to 2010………………………………………

Figure 4.2: Trends of GDP growth from 1970 to 2010……………………………..

viii

LIST OF ABBREVIATIONS AND ACRONYMS ADF

–

Augmented Dickey Fuller

AGC

–

Ashanti Goldfield Corporation

AGOA

–

Africa Growth and Opportunity Act

DIC

–

Divestiture Implementation Committee

ERP

–

Economic Recovery Programme

FDI

–

Foreign Direct Investment

FIE

–

Foreign Investment Enterprises

FINSAP

–

Financial Structural Adjustment Programme

GDP

–

Gross Domestic Product

GFCF

Gross Fixed Capital Formation

GIPC

–

Ghana Investment Promotion Centre

GNPC

–

Ghana National Petroleum Corporation

GSS

–

Ghana Statistical Service

IMF

–

International Monetary fund

IPA

–

Investment Promotion Agencies

ISSER

–

Institute of statistical Social and Economic Research

LDC

–

Least Developed Country

MNE

–

Multi-national Enterprise

OLS

–

Ordinary Least Square

PNDC

–

Provisional National Defence Council

R&D

–

Research and Development

SAP

–

Structural Adjustment Programme

SMEs

–

Small and Medium Enterprises ix

SOEs

–

State Owned Enterprises

SSA

–

Sub- Saharan Africa

TNCs

–

Transnational Corporations

UNCTAD

–

United Nations Conference on Trade and Development

VAR

–

Vector Auto-regression

VECM

Vector Error Correction Model

CHAPTER ONE INTRODUCTION 1.1

Background of the study Inadequate capital and investment due to low savings has had negative influence on economic growth of developing countries including those in sub-Saharan Africa. Most developing countries including Ghana have had difficulties or limited options especially when it comes to financing long term investment. As developing countries strive to achieve a middle-income status, the quest for long term investment has become more imperative. Foreign Direct Investment (FDI) has been identified as one of the sources of long term investment that could guarantee long term economic growth and eventually transform developing economies into middle-income economies.

Even though the annual FDI flow to Africa has increased nine fold from US$2 million in the 1980s to about US$18 million in 2003 and 2004, current findings by the UNCTAD, the world investment report (2011) have shown a positive but weak relationship between FDI and economic growth in Africa. In Ghana, 175 new projects were registered in 2009 with a total FDI component of GHC 260.378 million (US$185.987 million) which was expected to create or generate 18,119 jobs (Ghanaâ&#x20AC;&#x2122;s Budget Statement, 2010). FDI has been viewed by policy makers as a major source of financing developing countries economic growth. This is because of its ability to deal with two major obstacles of development which are shortage of financial resource and technology and skills transfer. The transfer of technology, skills, innovative capacity, and organisational and managerial practices between countries is also enhanced through the activities of foreign direct investors. It is also beneficial in that it helps the host country access international marketing networks. However, these positive effects 1

may vary in their magnitudes depending on the quality of the business environment in the host economy and the characteristics of the multinational company (Abdulai, 2005).

The importance of technology for economic growth provides an important link between FDI inflows and Ghanaâ&#x20AC;&#x2122;s economic growth. It is theoretically straightforward to argue that inflows of FDI have a potential for increasing the rate of economic growth in the country. Inflows of physical capital resulting from FDI could also increase the rate of economic growth but it is argued that the most important effect comes from spill over of technology. Multinational enterprise (MNE) operations in the host country can result in technology spill over from FDI whereby domestic firms adopt superior MNE technology which enables them to improve their productivity. Technology spill over thereby generate a positive externality that should allow the host country to enhance its long-run growth rate (Johnson, 2005).

Despite the straightforwardness of the argument, empirical evidence on a positive relationship between FDI inflows and host countryâ&#x20AC;&#x2122;s economic growth has been elusive. When a relationship between FDI and economic growth is established empirically, it tends to be conditional on host country characteristics such as the level of human capital, as indicated in de Mello (1999) and Borensztein et al (1998). The difficulty in proving a positive effect from FDI on economic growth provides a strong incentive for further empirical studies. Neoclassical models of economic growth only allow FDI to have a level effect on growth due to diminishing returns to capital. However, the endogenous growth theory provides a framework for studying the link between FDI and economic growth that makes it possible to take the characteristics of FDI into account and should improve the chances of confirming the theoretical relationship by empirical evidence.

The impact of FDI on the receiving country may be varied, though its positive contribution to resource availability, capital formation, transfer of managerial and organizational practices, skills and technology and access to international market networks cannot be over emphasized, the host countryâ&#x20AC;&#x2122;s ability to take advantage of all these benefits of FDI depends to a large extend on the openness of the country, business environment, political and economic stability and a host of other factors.

The role played by FDI in developing countries has been an attractive subject for many theoretical and empirical studies. However, there are still inconclusive arguments in relation to the impact of FDI on economic growth. One school of thought is the opinion that FD I inflows have a positive impact on economic growth while the other school of thought is of the opinion that FDI inflows have no impact on economic growth.

The first school of thought sees FDI inflows as a means of changing the factor endowment of a country and increasing the stock of real physical capital of a country (Zheng et.al. 2000). Furthermore, FDI is seen as a major channel for technological diffusion from developed countries to developing countries because of the advanced technology embodied in the new capital equipment (Balasubramanyam et. al. 1996).

The second school of thought argues that FDI inflows are not put into productive ventures and hence they do not lead to the accumulation of real physical capital and therefore they do not have any growth impact on an economy.

1.2

Statement of problems 3

Ghana is one of the major recipients of Foreign Direct Investment in sub- Saharan Africa. Inflows of Foreign Direct Investment into the country have been increasing over the years. In 2003, Foreign Direct Investment inflows into Ghana were US$137 million and increased marginally to US$139 million in 2004. Foreign Direct Investment inflows into Ghana were US$156 million in 2005, representing an increase of 12.2% from 2004 (World Investment Report, 2006) and whilst in 2009, FDI inflows were GHC 260.378 million estimated to be US$185.987 million (Budget Statement, 2010). The FDI inflow in Ghana were US$636 million in 2006, US$855 million in 2007, US$1,220 million in 2007, US$ 1,685 million in 2008 and US$2,527 million in 2009 (UNCTAD, world investment report, 2011)

In terms of stock of foreign direct investment in Ghana, as at 1990 it stood at US$319 million and increased to US$1,493 million in 2000. In 2005, the stock of FDI in Ghana was US$2073 million. This means that between 2000 and 2005 the stock of FDI has increased by almost 39%.

Growth in gross domestic product (GDP) in Ghana has been increasing over the years. In 2000, gross domestic product grew by 4%, 5.8% in 2005 and has increased to 6.2 % in 2006 representing a 2.2% points increased from 2000 (Ghanaâ&#x20AC;&#x2122;s Budget statement, 2006). The GDP growth of 4.7% was realized in 2009 but the industrial sector grew by 3.8% down from an annual growth target of 5.9% while the services sector grew by 4.6% against a target growth rate of 6.6% (Ghanaâ&#x20AC;&#x2122;s Budget statement, 2010). A number of factors have been associated with the performance of the economy in terms of gross domestic product. These include the existence of macroeconomic stability such as the stability of the exchange rate, low interest rate, low inflation etc. The question that one may ask is: Has the massive inflow of foreign direct investment into Ghana had a positive impact on growth in Ghana? 4

1.3

Objectives of the study Consistent with the research problem, the broad objective of this study is to examine the impact of FDI on Economic Growth in Ghana using an annual time series data from 19702010. In order to achieve this broad objective of the thesis, the following specific objectives were pursued:

ď&#x201A;ˇ

To find causal link between foreign direct investment and economic growth;

ď&#x201A;ˇ

To examine the trends in both FDI and economic growth in Ghana;

ď&#x201A;ˇ

To make recommendations to policy makers on the effects of FDI on economic growth in Ghana and ways to derive maximum benefits.

1.4

Research hypothesis In order to achieve the stated objectives, the study will test the following null hypotheses: H0: foreign direct investment has no impact on economic growth in Ghana H1: foreign direct investment has positive impact on economic growth in Ghana

1.5

Relevance of the study Throughout the last three decades, Ghana has been a significant recipient of foreign inflows and is among the top 20 countries in sub-Saharan Africa (UNCTAD, 2003). More importantly, Ghana has undergone a policy transition from controls in the1960s and 1970s, through to the economic recovery programme (ERP) and structural adjustment programmes (SAP) and to a more market economy in recent years. There have also been a number of policies aimed at attracting FDI to increase growth. 5

The study is relevant in the sense that it focuses on measuring the effects of FDI on economic growth in Ghana. This will help policy makers to maximize the benefits of foreign direct investment. The study also contributes to the empirical literature of the relationship between FDI and economic growth in Ghana.

1.6

Organization of the study The study is organised into five main chapters. The first chapter is the introduction and focuses on the background of the study, statement of problems, objectives and research hypothesis, relevance of the study and organisation of the study. Chapter two deals with the overview of the economy and emphasises on the trends in FDI and economic growth in Ghana. Chapter three takes a critical look at the theoretical and empirical literature on FDI and economic growth and make concluding remark on the literature.

Chapter four

discusses the methodology and analysis of finding where method of data collection, model specification, description of variables and the presentation of analysis and discussion of results. The finally, chapter five provide the summary of findings, conclusions and policy recommendations.

CHAPTER TWO OVERVIEW OF GHANAâ&#x20AC;&#x2122;S ECONOMY AND FDI 2.1

Introduction This chapter deals with the overview of Ghanaâ&#x20AC;&#x2122;s economy and emphasises on the trends in FDI and economic growth in Ghana as well as the contribution of FDI. The chapter is arranged as follows: section 2.2 is the review of trends in FDI in Ghana, section 2.3 is the determinants of FDI in Ghana, section 2.4 discusses the contribution of FDI in the Ghanaian economy whilst section 2.5 deals with the challenges of FDI in Ghana with section 2.6 tackling the regulatory framework and the last section 2.7 is the conclusion.

2.2

Review of trends of FDI in Ghana One of the main aims of the Government of Ghana in recent years has been to instil confidence among investors and create an attractive environment for foreign direct investment (FDI). Ghana was among the first countries in Africa to pursue economic reforms. Yet FDI trends have not been sustained, and Ghana has not been able to reap the benefits that a more stable inflow of investments could bring (UNCTAD, 2003).

Ghana has a long, though modest, history of FDI. The early foreign establishments date back several centuries. In more recent times, FDI was mainly in import substitution manufacturing. Annual inflows were as high as US$68 million for about two years, but were much less in most years, even slipping to negative numbers (net outflows) in the late 1970s, and hovering at under US$5 million in the mid-1980s. With the introduction of the Economic Recovery Programme (ERP) in 1983, Ghana undertook a relatively successful transition from an administrative system of economic management to a market economy. Gross domestic product (GDP) grew at an average annual rate of 5.4% between 1984 and 7

1990 and gross fixed capital formation (GFCF) doubled as a percentage of GDP. FDI remained sluggish in the years immediately following the start of recovery programme, accounting for less than 1% of GDP. However, it soon picked up and during the period 1991-1995, Ghana was considered a front runner, ranking among the top 10 investment locations in Africa.

The increase in FDI was triggered by the adoption of policies in 1986 to attract investment in natural resources. Investor response to the new mining law enacted in 1986 was positive, causing a surge of investment similar to a mini “gold rush”. The divestiture programme also attracted FDI. When privatisation began in 1988, there were 350 State-owned enterprises (SOEs), many of them unprofitable. The programme had a slow start and in the first round of divestitures, only 55 SOEs were privatized while another 31 firms were liquidated. A turning point came in 1994, when the Government put its most priced asset, Ashanti Goldfields Corporation (AGC), on the market. Consequently, 1994 saw an abrupt peak in FDI flows of US$233 million, reflecting the partial sale of AGC to the South African mining company called Lonmin. This deal, one of Africa’s largest privatisation to date, put Ghana in the spotlight for international investment. FDI also flowed to services. Among another six divestitures in 1994, were those of Accra Breweries and Standard Chartered Bank. One of the most recent peak of FDI inflows was registered in 1996 when Telekom Malaysia bought 30% of the shares of the then State-owned Ghana Telecom (UNCTAD, 2003) which is currently owned by British Telecommunication Company called Vodafone Limited.

According to Tsikata et al. (2000), the historical trend of FDI flows in Ghana can be shown in three main phases since 1983. The period 1983-88 witnessed sluggish inflows, averaging 8

about US$4 million per annum, and the highest and lowest inflows during the period being US$6 million in 1985 and US$2 million in 1984 respectively. 1989-92 recorded moderate inflows averaging about US$18 million per annum the highest and lowest being US$22 million in 1992 and US$14.8 million in 1990 respectively.1993-96 was a period of significant, but oscillatory inflows, which peaked in 1994 at US$233 million, but fell by more than 50% the following year to US$107 million. An equally important feature of the FDI inflows according to Tsikata et al (2000) is the three-way nexus of economic growth, investment and political stability, which has emerged since the coup dâ&#x20AC;&#x2122;etat of 1972. In that year, a growth rate of 2.3% was recorded, accompanied by a more than 60% drop in FDI (from US$30.6 million in 1971 to US$11.5 million in 1972). In 1979 when Rawlings took power and adopted anti-business stance, growth fell to as low as â&#x20AC;&#x201C;3.2%; there was also an outflow of US$2.8 million of FDI. The state of the economy worsened further in his second advent, namely, from a negative growth rate of 3.5% in 1981 to 6.9% in 1982; however inflow of FDI remained constant at US$16.3 million. The relationship emerged again when a parliamentary democracy replaced the military junta in 1992. The rate of growth of 5.3% in 1991 fell to 3.9% in 1992; this has been previously attributed to deficit financing undertaken to finance the democratic process. The FDI flow however, increased from US$20million in 1991 to US$22.5million in 1992.

It is significant to note that, the quality of FDI statistics in Ghana tend to be questionable since the promotion and monitoring of FDI in Ghana are carried out by several agencies without proper coordination in arriving at a total figure. Since 1994, however, the Ghana Investment Promotion Centre (GIPC) has registered over 1281 projects (Abdulai, 2005).

2.3

Determinants of FDI in Ghana A number of studies examine the determinants of capital flows to developing countries. These studies tend to look first at capital flows generally and then to focus specifically on foreign direct investment. In general, the studies divide the factors influencing capital flows into developing countries into push and pull factors. The push factors, which are external to developing countries, focus on growth and financial market conditions in industrial countries. According to Calvo et al. (1993), total flows are driven primarily by push factors, mainly growth and interest rates in industrial countries. Mody and Murshid (2001) found that developments within an individual developing country tend to raise capital to that country by increasing the share of total flows allocated to that country. The push (external) factors determine the pool of funds available to LDC, while the pull factors determine their allocation among less developed countries (Collins, 2002).

The pull factors depend on a long list of domestic policies and characteristics of potential host countries. Among the various indicators are macroeconomic policy and performance (growth, the external balance, real exchange rate over-valuation and exchange rate regime, financial market development); indicators of current and capital account openness; tax levels and existence of incentives to encourage capital inflows; measures of the quality of legal and other institutions (including corruption); conflict measures; political regime and; size of domestic markets and natural resource base.

Relatively high degree of uncertainty in Sub-Saharan Africa is one of the reasons why foreign investors are reluctant to invest in Africa including Ghana. Despite the enormous profitable opportunities in Ghana and the rest of the sub region, the uncertainty in the 10

region, which exposes firms to significant risks, has prevented a lot of foreign investments. Uncertainty in the Sub-Saharan African region manifests itself in three different ways: Political instability: The region is politically unstable because of the high incidence of wars, frequent military interventions in politics, and religious and ethnic conflicts. There is some evidence that the probability of war––a measure of instability––is very high in the region. In a recent study, Rogoff and Reinhart (2003) computed regional susceptibility to war indices for the period 1960-2001. They found that wars are more likely to occur in Africa than in other regions. The regional susceptibility to war index is 26.3% for Africa compared to 19.4% and 9.9% for Asia and the Western Hemisphere respectively. The study also showed that there is a statistically significant negative correlation between FDI and conflicts in Africa. Sachs and Sievers (1998) have also argued that political stability is one of the most important determinants of FDI in Africa.

Macroeconomic instability: Instability in macroeconomic variables as evidenced by the high incidence of currency crashes, double digit inflation, and excessive budget deficits, has also limited the regions ability to attract foreign investment. Recent evidence based on African data suggests that countries with high inflation tend to attract less FDI (Onyeiwu and Shrestha, 2004).

A stable financial and macroeconomic environment can go a long way toward reducing the degree of uncertainty investors face in a country. In Ghana, Financial Structural Adjustment Programme (FINSAP) has helped to reform the banking sector to ensure the appreciation of the value of the customer and provide customer satisfaction; overhaul the regulatory framework and improve bank supervision; develop the money and capital markets; increase exports and sustain GDP growth of at least 5% per annum; and control inflation through 11

appropriate fiscal and monetary policies. The Ghana financial sector was deregulated under an adjustment program launched in 1996. The period of 1992â&#x20AC;&#x201C;1996, however, saw a resurgence of economic instability. However, through FINSAP, the financial system in Ghana has evolved appreciably. The distressed banks have been restructured and the number of banks has increased from 5 to 15 as of October 2001. In addition, there are presently about 125 rural/community banks that are complementing the efforts of the 25 major banks in providing finance to small and medium-sized enterprises. This has made the environment conducive for FDI in Ghana (Mmieh and Frimpong, 2004)

Further on the macroeconomic stability in Ghana, the Foreign Exchange Market has been liberalized with the licensing of forex bureaus to buy and sell foreign exchange together with the banks. Whereas there is no restriction on the amount of foreign exchange one could bring into the country, all remittances beyond $5,000 out of the country are subject to approval from the central government. The growth of treasury bills in the 1990s has played a part in diverting funds from the private sector to the government. Partly because of the high interest rates in the domestic market and also because of the weak economy, demand for bank resources tends to be quite low. The short-term objectives of the government to mop up excess liquidity in the economy through the sale of treasury bills had the effect of diverting financial resources away from the productive sector. Most government efforts to restore the productivity of the Ghanaian economy have been directed toward only boosting the countryâ&#x20AC;&#x2122;s exports. By promoting exports, the government sought to obtain foreign exchange to repay debts and ease the countryâ&#x20AC;&#x2122;s restrictions on imports, which, of course, are also necessary to upgrade many of the export industries hamstrung for lack of equipment and thus attract FDI.

Lack of policy transparency: In several African countries it is often difficult to tell what specific aspects of government policies are. This is due in part to the high frequency of government as well as policy changes in the region and the lack of transparency in macroeconomic policy. The lack of transparency in economic policy is of concern because it increases transaction costs thereby reducing the incentives for foreign investment.

Apart from uncertainty, there are other determinants which affect the attraction of FDI in developing countries including Ghana. these are inhospitable regulatory environment, poor infrastructure, poor and ineffective marketing strategy, and corruption and weak governance.

The lack of a favourable investment climate also contributed to the low FDI trend observed in the region. In the past, domestic investment policies––for example on profit repatriation as well as on entry into some sectors of the economy––were not conducive to the attraction of FDI (Basu and Srinivasan, 2002). Table 6 shows the cost of regulation of entry of new firms in selected countries in Africa and Asia. Clearly the costs of entry, as a percentage of 1997 GDP per capita, are very high in Africa relative to Asia. Within Africa, the costs are higher in Burkina Faso (133.4%), Senegal (99.6%), Nigeria (99.3%), and Tanzania (86.8%). GDP growth and market size: Relative to several regions of the world, growth rates of real per capita output in Africa are low and domestic markets are quite small. This makes it difficult for foreign firms to exploit economies of scale and so discourages entry. Elbadawi and Mwega (1997), show that economic growth is an important determinant of FDI flows to the region. The absence of adequate supporting infrastructure: telecommunication; transport; power supply; skilled labour, discourage foreign investment because it increases transaction costs. Furthermore poor infrastructure reduces the productivity of investments thereby 13

discouraging inflows. Asiedu (2002b) and Morrisset (2000) provide evidence that good infrastructure has a positive impact on FDI flows to Africa. However, Onyeiwu and Shrestha (2004) find no evidence that infrastructure has any impact on FDI flows to Africa.

Weak law enforcement stemming from corruption and the lack of a credible mechanism for the protection of property rights are possible deterrents to FDI in the region. Foreign investors prefer to make investments in countries with very good legal and judicial systems to guarantee the security of their investments. In the past, African governments set up agencies to promote foreign investment without taking adequate steps to lift the constraints on foreign direct investment in the region. It is therefore not surprising that investment promotion activities in the region have not been as successful as expected. Apart from the idea that promotion activities in the region started earlier than necessary, there is also the problem that Investment Promotion Agencies (IPA) created by domestic governments were highly bureaucratic, expensive to maintain, and have not been successful in reversing the declining trend in FDI flows to the region.

The overall of the determinants of FDI is that the location that attracts and provides a sufficiently high rate of return. These are countries that exhibit substantial macroeconomic and political stability, and therefore have favourable growth prospects. In addition, countries that attract FDI are likely to possess good infrastructure and legal systems (including the enforceability of contracts); a skilled labour force; and a liberalized foreign sector. Important as well is the availability of a large domestic market and natural endowments. Determinants of FDI, therefore, include the openness of the host country; political risk, measured for example by a countryâ&#x20AC;&#x2122;s credit rating; financial depth; government size, as represented by the ratio of governmentâ&#x20AC;&#x2122;s consumption to GDP, for example; and the 14

economic growth as a measure of the attractiveness of the host country’s market. A study by Tsikata, Asante and Gyasi (2000) showed that the following factors were significant determinants of FDI to Ghana over the period of the study (1970–1997): trade regime, democratic governance, investment climate, economic uncertainty and raw material availability (because the mining sector is ore dependent). Yet, recent literature also suggests that the responsiveness of FDI to the traditional variables, such as the rate of return on investment, infrastructure and openness, may be lower for SSA than for non-SSA countries. The relative influence of the various determinants of FDI will also vary with the type of FDI. One or several of the following major categories of FDI have been attracted to subSaharan Africa (SSA): Investments to exploit natural resources; Investments that are attracted by other “specific” locational advantages; Investments resulting from the host country’s active investment policies to attract FDI and; Investments that respond to economic and structural reforms, including privatization (Asante, 2006).

2.4

Contribution of FDI to the Ghanaian economy External capital inflows have been important for Ghana but the share of FDI in these inflows has been small. There is a considerable gap between savings and investment: in 1980-1999, domestic savings as a proportion of GDP was about 6 per cent compared to an average of 16 per cent for sub-Saharan Africa; while domestic investment as a proportion of GDP was 13.9 per cent, compared to an average of 19.1 per cent for sub-Saharan Africa.7 The savings-investment gap has been bridged through external capital flows. The contribution of FDI to capital formation in Ghana was low (5 per cent) compared to the average for sub-Saharan Africa in 1996-1999.

FDI has had direct and multiplier effects on the level of employment, its quality, and the skills of the labour force. But in some sectors it has not contributed to promoting labourintensive activities. In mining, for example, capital-intensive production has created relatively few low-skilled jobs but it has led to productivity improvements and skills upgrading. Over time, Ashanti has built its own engineering and managerial capabilities and it has programmes for training and enhancement of labour force skills. In other sectors, estimates for the GIPC-registered projects suggest that $1.4 billion of FDI generated jobs for 72,384 Ghanaians and 4,652 non-Ghanaians over 1994-2002. Local employment creation, not particularly high, was mainly in manufacturing, which accounts for 30 per cent of total employment in registered projects. FDI linkages are also noticeable. An UNCTAD survey10 of small and medium sized enterprises (SMEs) with linkages with foreign firms or export activity shows that firm size has increased in the last five years (table I.3). Whereas in 1995 only one third of the sampled firms employed more than 20 people each this had increased to almost three quarters of the firms by 2000.

According to Mmieh and Frimpong (2004), from 1994 to 2002, FDI projects created a total of 73,700 jobs, of which 94% were offered to Ghanaians and about 6% went to nonGhanaians. Thirty-one percent of jobs created were in the manufacturing sector, and approximately 20% went into the service sector. The building and construction sector received approximately 15.4%. The share of jobs in general trading was approximately 5.5%. Tourismâ&#x20AC;&#x2122;s share was 5%, compared with only 2% in the trade and export sector. The distribution of jobs among the sectors shows that the role of FDI goes some way to enhance economic performance in Ghana.

The diffusion of technology by foreign firms has also encouraged the emergence of new occupational groups, enhanced skills and improved productivity in selected industries and services. Generally, enterprises in Ghana have low technical capability and low productivity. A survey of five industries â&#x20AC;&#x201C; textiles, garments, food processing, woodworking and metalworking â&#x20AC;&#x201C; concluded that the general level of technical capacity in Ghana was very low by the standards of not only developed countries but also of industrializing countries in Asia and Latin America (UNCTAD, 2003). Notwithstanding the difficult operating conditions, FDI has increased significantly the stock of technology by providing machinery and equipment and it has helped build up local industrial capabilities by contributing to skills formation. This contribution has been strong in the exploitation of natural resources, where the use of capital-intensive technology has developed a pool of trained labour. Capital-intensive technology used in mining has also resulted in the shifting of surface open-pit operations underground. FDI has also brought technology and marketing knowledge to new export-oriented industries such as agribusiness and downstream processing industries (e.g. wood and fish processing). In agriculture, the transformation of traditional farming geared to local consumers into intensive production for export has involved the adoption of a new set of technologies. Pineapple and organic vegetables are successful examples. Services have benefited from the new information technology, distribution and logistic support of the transnational corporations. According to firms surveyed by UNCTAD, product improvement, constituted the most relevant support to local firms, followed by training, provision of machinery and equipment together with information on market opportunities.

2.5

Challenges of FDI in Ghana Factors such as political and macroeconomic instability, low growth, weak infrastructure, poor governance, inhospitable regulatory environments, and ill-conceived investment promotion strategies, are identified as responsible for the poor FDI record of the subSaharan regions.

One of the major disincentives to investment in Ghana remains the land acquisition problem. Land reforms are urgently needed to ensure that investors can lay claim to their property within a legal framework. In 2002, AGOA was given the responsibility to urge regional chiefs to streamline land acquisition procedures to make them less cumbersome for investors (â&#x20AC;&#x153;U.S.-Africa Business Summit,â&#x20AC;? 2003). Evidence exists that FDI inflows are mostly concentrated in the Greater Accra region. This study notes that the state is making every effort, through AGOA, to ensure that other regions of the country have a reasonable share of FDI distribution. However, the complex web of regulatory controls and bureaucratic interventions are of particular concern. Also, the lack of adequate infrastructure - particularly, transport, telecommunications, and road networks - is a major constraint of FDI inflows into some regions in the country.

The importance of perceived levels of corruption in investor decision making processes cannot be underestimated. Van Vuuren (2002), among several other empirical studies, shows, in fact, that corruption, complex and non transparent regulatory framework, as well as property rights, all hamper the attraction of FDI. The overarching observation of this work is that research findings based on actual incidences where foreign investors decided not to invest because of corruption are hard to come by. He argues that some anecdotal evidence, however, supports the ranking given to corruption as a decisive factor in 18

influencing capital inflows. As an example, the author uses the case of Zimbabwe, which lost a hotel complex investment worth US$55.8 million to Zambia when Sun International chose to relocate there in 2000, citing problems associated with unnecessary red tape and demands for bribes by those in positions of authority. Wei (1998) studied the effect of corruption on FDI. The central finding of that research is that a rise in either the tax rate on multinational firms or the corruption level in a host country reduces inward FDI. In Ghana, the Mabey and Johnson case in 2010 which claims that the company gave out some amount of money to some ministers of state to win contract during a hearing in a UK court can reduce the confidence in foreign investors about transparency of the business environment.

2.6

The regulatory framework Openness to FDI has been a tenet of Government policy for many years (UNCTAD, 2003). The Ghanaâ&#x20AC;&#x2122;s policy of encouraging foreign investment is demonstrated in many ways, including sending investment missions abroad and hosting major international events that focus on foreign direct investment. Notable among these events were the 5th AfricanAmerican Summit and the 3rd Pan African Investment Summit held in May and September 1999 respectively. These events generated much renewed interest to invest in Ghana (Abdulai, 2005).

The privatisation program embarked upon by the country in the early 1990s has also helped in attracting significant inflow of private foreign capital into the economy. The program resulted in the sale of more than two-thirds of approximately 300 state-owned enterprises. Majority of the firms were acquired by foreign investors with few local investors partnering their foreign counterparts to acquire others. The Divestiture Implementation Committee 19

(DIC) is the government institution that oversees the privatisation of these enterprises, which conduct the divestiture process through a bidding process. The winning bids are evaluated on the basis of many criteria, including management skills, financial resources and business plans. It is expected that the new owner is able to build the enterprise into a profitable, productive venture that contributes to the tax revenue and employs Ghanaians. The privatisation process seems to have slowed down a little for some time now (Abdulai, 2005).

In 1994, Ghanaâ&#x20AC;&#x2122;s Parliament enacted and promulgated the Investment Promotion Centre Act to regulate all FDI, except in minerals, oil and gas and the free zones. Sector specific regulations also apply to FDI in fishing, forestry, and certain services such as banking, insurance and real estate. The Act was aimed at easing the establishment of businesses and attracting investment. It created the Ghana Investment Promotion Centre (GIPC) to deal with all aspects of the FDI regulatory framework, in sectors covered by the Act.

Investors intending to do business in Ghana first have to register as business entities (i.e. Limited Liability Company, partnership or sole proprietorship) with the Registrar-Generalâ&#x20AC;&#x2122;s Department under the relevant laws. Enterprises with any foreign participation (i.e. wholly foreign-owned enterprises or joint ventures) must then register with GIPC indicating the amount of foreign capital invested. Under the GIPC Act, wholly foreign-owned enterprises must have a paid-up capital equivalent to $50,000. Where the foreign investor intends to enter into a joint-venture partnership with a Ghanaian, a lesser minimum equity capital of $10,000 is required. Minimum capital requirements are low compared to other developing countries. Foreign investment in trading companies faces more stringent entry requirements. 20

Trading companies, whether wholly or partly foreign owned, require a minimum foreign equity of $300,000 and the firm must employ at least 10 Ghanaians. The higher minimum investment (required in trading companies) is clearly intended to dissuade foreigners from engaging in this kind of activity. The law, however, recognizes that FDI might be necessary in larger businesses - for example in the retail trade and supermarket chains.

Even though the GIPC law governs investment in all other sectors, sector-specific laws also regulate those sectors such as banking, non-banking financial institutions, insurance, fishing, securities, and real estate. A foreign investor is required to satisfy the provisions of the investment act as well as the provisions of the sector-specific law. An example is investment in banking, where laws specific to the banking sector apply in addition to the GIPC law. The GIPC law applies to foreign investment through acquisitions, mergers, takeovers, as well as new investments. The law is also applicable to portfolio investment in stocks, bonds, and other securities traded on the Ghana Stock Exchange. The law also specifies areas of investment reserved for Ghanaians, namely, petty trading, operation of taxi services (except when a non-Ghanaian has a minimum fleet of 10 vehicles), pool betting businesses and lotteries (except soccer pools), beauty salons and barber shops. It also specifies the minimum foreign capital requirement for non-Ghanaians. The law further sets out incentives and guarantees that are applicable to enterprises registered under the law. These incentives and guarantees relate to taxation, transfer of capital, profits and dividends and guarantees against explorations (Abdulai, 2005).

The screening of investment has also ceased since the enactment of the GIPC law. The GIPC registers investments, promotes both domestic and foreign investment in Ghana, and 21

provides all the necessary assistance that enables an investor to become established. The Government has no identifiable overall economic or industrial strategy that has a discriminatory effect on foreign-owned businesses. In some cases, a foreign investor can enjoy additional incentives if the project is deemed to be very critical to the country's development.

Investment in minerals and mining is regulated by the Minerals and Mining Law, 1986 (PNDCL 153) as amended by the Minerals and Mining Amendment Act, 1994 (Act 475). Essentially, the law regulates investment in mining with the exception of investment in small-scale mining, which is reserved for Ghanaians. Also, the law specifies different types of mining rights, issues relating to incentives and guarantees, and land ownership. The Minerals Commission is the government agency that implements the Minerals and Mining law.

The Petroleum Exploration and Production Law 1984 (PNDCL 84), known as the Petroleum Law regulates the exploration and production of oil and gas in Ghana. The law deals extensively with petroleum contracts, the rights, duties, and responsibilities of contractors and compensation payable to those affected by activities in the petroleum sector. The Ghana National Petroleum Corporation (GNPC) is the government institution that administers this law. A couple of foreign companies have been actively involved in oil/gas exploration in Ghana, although none is active at the present time.

2.7

Conclusion Ghana is well endowed with many valuable natural resources, and is strategically well placed for access to markets in Europe and the rest of Africa. Investors can benefit from increased regional integration - which opens new potential linkages throughout West Africa - beyond the traditional boundaries that previously separated the region. They can also benefit from recent measures for improved access to markets in Europe and the United States. The proposed reduction of tariffs between countries in the region and the new multilateral and bilateral agreements are expected to boost trade. The streamlining of import/export procedures and the implementation of other reforms by the Gateway Project has strengthened existing linkages between FDI and trade. In attracting FDI, however, Ghana needs to encourage domestic growth and foster linkages, particularly between transnational corporations and SMEs. To develop clusters in the main sectors with FDI potential, effective linkages and synergies need to be created. Policy measures to facilitate cluster establishment may include specific programmes to set up partnership schemes between

SMEs and transnational

corporations,

develop incubators and initiate

microenterprise development programmes. The upgrading of free zones into industrial parks would also induce the geographic concentration of exporters, thereby enhancing horizontal linkages. A change in policy tack is also needed in the area of education, Science and Technology for the development of skilled, adaptive and innovative human resources. Education, Science and Technology should be more focused so as to respond to the needs of the private sector.

CHAPTER THREE LITERATURE REVIEW 3.1

Introduction In this chapter, the theoretical and empirical literature on Foreign Direct Investment and economic growth are discussed. The rest of the chapter is organised into three parts as follows: the first part which is section 3.2 discusses the theoretical literature on FDI, relationship between FDI and economic growths, and impact of FDI on economic growth. The second part which is section 3.3 reviews the empirical literature on relationship and impact of FDI on economic growth whist the last part of the chapter which is section 3.4 makes concluding remarks on the literature review.

3.2

Theoretical literature

3.2.1

Theory of FDI Foreign direct investment is often seen as an important catalyst for the economic transformation of the transition economies and developing countries. Its importance is seen to be not only in providing finance for the acquisition of new plants and equipment, but also in the transfer of technology and organisational forms from relatively more technologically advanced economies. FDI is especially important for its potential to transfer knowledge and technology, create jobs, boost overall productivity, enhance competitiveness and entrepreneurship, and ultimately eradicate poverty through economic growth and development (The “Monterrey Consensus”, United Nations International Conference on Financing for Development, 2002). FDI can also result in positive “spillovers” to the local economy through linkages with local suppliers, competition, imitation and training. In addition, it can result in negative spillovers if it forces domestic enterprises to close down 24

because they cannot obtain the necessary financing for upgrading their technology. Moreover, it is possible that spillovers to the rest of the economy may not occur at all if there are institutional obstacles or deficiencies in the absorptive capacity of domestic enterprises (Lyroudi, Papanastasiou, And Vamvakidis, 2004).

As finance, FDI represents an inflow of foreign resources that can raise domestic savings rates in the recipient countries. This finance can include purchases by the foreign direct investor of equity capital (including additional paid up capital) in the Multinational Enterprises, reinvestment of profits by the Multinational Enterprises and loans to the Multinational Enterprises from the parent firm. The Multinational Enterprises may also borrow abroad on its own account (although such funds are not classified as FDI). If the Multinational Enterprises uses these funds to build a new facility or upgrade an existing one, domestic fixed investment increases. Normally this involves a mix of domestic and imported inputs, especially foreign machinery and equipment. However, FDI also includes the acquisition of existing plants and equipment, in which case there is a transfer of title to existing assets rather than the creation of new ones. Also the profits of Multinational Enterprises and funds from abroad may be placed in purely financial investments. In these cases, FDI does not have a direct impact on real investment, although an acquisition can result in the transfer of new technology and organizational forms over time.

According to the ideas of Hymer (1960), it has been argued that Multinational Enterprises have firm-specific advantages that allow them to operate profitably in foreign countries. Examples of firm specific advantages include superior technology, scale economies and management. It is possible to link the idea of firm-specific advantages to the concept of knowledge capital. Knowledge capital has been important for recent development of FDI 25

theories and has been included in new trade models analysing FDI, such as Carr et al. (2001) and Markusen and Maskus (2002). Knowledge capital is a broad concept that consists of intangible assets such as brand name, human capital, patents, trademarks and technology. Markusen (2002) argues that knowledge-capital is important for Multinational Enterprises based on the fact that they tend to have large R&D expenditures, a large share of technical workers and produce technically advanced products. It is primarily Multinational Enterprises possession of knowledge-capital that is important for providing firm-specific advantages allowing Multinational Enterprises to operate profitably in multiple economies.

3.2.2

Relationship between FDI and economic growth In an open economy macroeconomic theory, technology and trade, especially through exports and imports promote economic growth (Grassman and Gelpman, 1997; Frankel and Romer, 1999; Frankel, Romer and Cyrus, 1996). However, according to Rodriguez and Rodrik (2000), growth has effects on trade. The role of trade policy on economic growth has been the focus of considerable academic effort. Openness, namely, the sum of exports and imports to gross domestic product (GDP), has been considered one of the main determinants of economic growth. Export expansion can increase productivity, offering greater economies of scale. Exports are likely to alleviate foreign exchange constraints and can thereby provide greater access to international markets (Dritsaki and Adamopoulos, 2004). Many early studies of the links between exports and growth confirm a statistical relationship between export and output growth (Michaely, 1977; Krueger, 1978; Balassa, 1978; and Fedder, 1982).

The relationship between trade openness and growth is a highly debated topic in the growth and development literature. Yet, this issue is far from being resolved. Theoretical growth 26

studies suggest at best a very complex and ambiguous relationship between trade restrictions and growth. The endogenous growth literature has been diverse enough to provide a different array of models in which trade restrictions can decrease or increase the worldwide rate of growth (Romer, 1990; Grossman and Helpman, 1990; Rivera-Batiz and Romer, 1991; Matsuyama, 1992). Note that if trading partners are asymmetric countries in the sense that they have considerably different technologies and endowments, even if economic integration raises the worldwide growth rate, it may adversely affect individual countries.

Numerous empirical studies at the firm, industry and economy-wide levels confirm that technical change and technological learning are important determinants of economic growth (Temple, 1999). Transnational corporations/ Multinational Enterprises are responsible for much of this technological accumulation, yet growth theory rarely acknowledges the important role that these organizations play. In neo-classical analysis, FDI does not influence the long-run growth rate, but only the level of income. An exogenous increase in FDI would increase the amount of capital (and output) per person, but this would only be temporary, as diminishing returns (on the marginal product of capital) would impose a limit to this growth. FDI can influence the long-run growth rate only through technological progress or growth of the labour force, which are both considered exogenous.

If FDI is not only finance but also a bundle of fixed assets, knowledge (codified and tacit) and technology, then it can be expected to generate growth endogenously. According to recent endogenous growth theory, FDI influences growth via variables such as R&D and education (or human capital) (Romer, 1986; Lucas Jr., 1988). Even if diminishing returns prevail inside the enterprise, various externalities (outside the enterprise) can provide the necessary positive feedback to sustain growth in the long run. Transnational corporations 27

create such positive externalities for the local economy when they transfer new technology and organizational forms directly to its affiliate. They can also create them indirectly through subcontracting, joint ventures and strategic alliances, technology licensing, imports of capital goods and migration.

Through technology transfer and technology spillovers, these growth models suggest that FDI can speed up the development of new intermediate product varieties (the horizontally differentiated inputs model), raise product quality (the quality ladder model), facilitate international collaboration on R&D, and introduce new forms of human capital (Romer, 1990; Grossman and Helpman, 1991; and Aghion and Howitt, 1992). By providing firms in relatively backward countries with greater access to finance and a wider range of intermediate products, FDI can increase productivity directly in the FIE and indirectly in local enterprises through knowledge spillovers. The existence of technology transfer and local spillovers prevent the unbounded decline of the marginal productivity of capital suggested in conventional growth theory and makes endogenously driven long-term growth possible.

It is usually assumed that FDI inflows stimulate growth. Such a relationship might be expected because FDI can enhance those factors which usually play an important role in promoting economic development i.e. investment, technical progress, and, in the new growth theory, R&D, the accumulation of human capital and various positive externalities. However, the causation may run in the other direction, whereby rapid economic growth attracts FDI. Under this hypothesis, expanding domestic economic activity is likely to be associated with an improving investment environment and increased opportunity for boosting profits. The expansion of income and domestic markets makes it possible for TNCs 28

to exploit economies of scale. In the longer term, growth associated improvements in human capital, labour productivity and infrastructure are likely to increase the marginal return to capital and, thus, the demand for domestic and foreign investment Zhang (2005). Improved economic performance should also generate profits and encourage their reinvestment.

3.2.3

Impact of FDI on economic growth For an analysis of impact on growth, exports, productivity and employment, there is a wide literature concerning various regression models. Most models use FDI flow or stock data and relate these data to various economic and social indicators. One way to analyse the impact of FDI on various economic variables is to use econometric methods. The following presents a set of simple regression equations which aim to explain the impact of FDI on economic growth, level of GDP, exports, productivity and employment:

3.2.3(a) FDI impact on economic growth: One of the most obvious variables to check for the impact of FDI on economic growth is to use a growth model similar to the Solow model, with Cobb-Douglas production including physical and human capital as in Romer (1996). In this framework, output is characterised as follows: where α>0, β>0, α+β< 1 . . . . . . . . .

(1)

In equation (1), Y denotes output, K is physical capital, H is human capital, A is the effectiveness of labour and L is labour. Defining k = K/AL, h = H/AL, and y = Y/AL, and using equation (1) yields: y = kα hβ

.................

(2)

Taking natural logs of equation (2) would result in: lny = αlnk + βlnh

............

(3) 29

In this case, dummy variables for three of the four quarters have to be included in the regression to eliminate seasonality effects. Also, initial GDP is no longer useful as it doe s not vary over time. Similarly, one might think about another proxy for human capital, given that secondary school enrolment does not greatly vary over time. In general, data for single years or quarters would be employed instead of period averages. Finally, the models employed have to be tested with regard to the underlying assumptions of the regression analysis, e.g. the normal distribution of the residuals and heteroskedasticity. Also, a sensitivity analysis, e.g. including additional variables, can be very useful for a better understanding of the analysed relationship.

3.2.3(b) FDI impact on GDP levels: A more sophisticated method such as panel regressions analysis may be employed. This can be used, for instance, in the analysis of FDI’s impact on the level of GDP. Our starting point for investigating the impact of FDI on GDP in a panel data Cobb-Douglas production function setting is a common worldwide production function expressed by: yit = ai + bt + F(kit, hit, fit)

............

(4)

Where y is the log output per capita, a is the level of total factor productivity, and b is the time dummy capturing changes in total factor productivity, while k, h and f represent the log of per capita inputs of physical capital, human capital and FDI, respectively. In this section we allow the production function F to be Cobb-Douglas, so that, in logs, we have: F(kit, hit, fit) = αkit + βhit + γfit

...............

(5)

In regard to estimating this production function, Canning (1999) emphasis that possible reverse causality might be a major problem where capital inputs may determine output, but output may also have a feedback into capital accumulation. Canning (1999) notes that the 30

output and capital variables might be non-stationary. As a consequence, the production function may represent a long-run co-integrating relationship. This should give consistent estimates of the parameters of the production function that are robust to reverse causality.

This type of analysis is very demanding and can even be extended with tools such as the trans-log specification developed in Canning and Bennathan (2000), which makes it possible to avoid the assumption of a constant elasticity of output with respect to input, imposed by the Cobb-Douglas production function, as well as to examine the pattern of complementarity and substitutability between inputs into the production function.

3.2.3(c) FDI impact on exports: Impact of FDI on export is provided by Vuksic (2005) using firm level analysis. Here the impact of FDI on exports of various industries j is analysed. The following model was estimated, inter alia: ... (6) Vuksic explains the variables used as follows: the dependent variable

is the natural

logarithm of real exports. The independent variables are the natural logarithms of a productivity index (

), a unit labour costs index lnULC and the real effective exchange

rate lnREER. Subscript j = 1, 2, ...N denotes different branches and t stands for different years. A fixed effects one-way error component model is used for the estimation. The constant term

denotes the branch-specific fixed effects. Domestic investment (lnI) and

FDI stock (lnFDI) variables enter the regression with a one-year lag. This can be justified by the fact that some time is needed before the new investment becomes effective. In the case of FDI, using lagged values should help to alleviate a potential simultaneity problem between exports and FDI variables. Using FDI stock values instead of inflows should also 31

help in this regard. In addition, FDI stock should better capture the relevance of the presence of foreign capital in some branch, which is important as a source of potential indirect effects. If only FDI inflow values were used, there might be cases in which a substantial inflow took place at the beginning of the observed period without there being any inflows afterwards. In this way, the values of this variable would be zero for all the subsequent years, which would neglect the strong presence of the foreign capital already invested; this could be a source of potentially important side effects (Hunya, Holzner and Worz, 2003).

3.3

The empirical literature Several studies have focused on theoretical positive impact of FDI on growth. But there are only few empirical studies of this facet. Both macro and micro studies have generally been conducted to study the relationship between FDI and growth. Micro studies find no positive evidence to support the assertion that FDI positively contributes to growth. Macro studies, have, however, thrown up some evidence to show that FDI positively affects economic growth under certain conditions. For instance, Balasubramanyam et al (1996) tested the hypothesis that export promoting FDI in countries like India confer greater benefit than FDI in other sectors. They have used production function approach in which FDI is treated as an independent factor input in addition to domestic capital and labour. As FDI is a source of human capital accumulation and development of new technology for developing countries, FDI captures such externalities as learning by watching and/or doing and various spillover effects. Exports are also used as an additional factor input in this production function. In their model, real GDP depends on labour, domestic capital stock, foreign capital stock, exports, and technical progress through time. Time is an all inclusive proxy variable which captures the influence of all factors, including changing technology, that are impounded under the assumption of ceteris paribus. Borensztin et al. (1998) examine absorptive 32

capacity of recipient country, which is measured by stock of human capital required for technological progress. Nair-Reichart and Weinhold (2001) postulate panel and time series estimators to impose homogeneity assumptions across countries in the relationship between FDI and growth. They marshal evidence to show considerable heterogeneity across countries. Assumption of homogeneity can result in biased estimates which tend to yield invalid inferences and furnish faulty policy guidelines. To circumvent the problem, the authors used mixed, fixed and random panel data estimation to test the causality between FDI and growth in developing countries. Results from mixed, fixed and random estimation differ substantially from those results furnished by panel data causality. However, traditional tests suggest significant and uniform impact of FDI on growth. Nair-Reichart and Weinhold (2001) find the causal relationship between investment (foreign and domestic) and growth in developing countries to be highly heterogeneous. They have, however, failed to examine the effect of multicollinearity arising from inter-relations between domestic and foreign investment. This compromises the reliability of their results of estimation and tests of significant. We may postulate that market size, composition and even choice of the recipient companies and their market shares would have a bearing upon the growth impact of FDI. Domestic investment is strongly correlated contemporaneously with growth, though it is generally not a strong determinant of growth. Besides, this study supports the evidence that efficacy of FDI is likely to be greater in more open economies. But it is highly heterogeneous across countries. The diversity of impact can be explained in terms of differences among countries and open economies are obviously likely to derive greater benefits from FDI simply because their openness not only permits acceptance of FDI but it also acts as an attraction for foreign investors than openness also make them depend on the growth of export earning as source of development.

Pramadhani, Bissondeeal and Driffield (2007) have examined the causal relationships between inward direct investment, growth and trade in Indonesia for the period 1990 –2004. They seek to establish whether there were strong, weak positive or negative associations between the presences of multinational enterprises and Indonesian exports and imports determent the causal links between the variables. The FDI has contributed significantly to Malaysia’s electronics exports as well as the growth and development of the electronics industry (Wong and Tang, 2007). Hsiao and Hsiao (2006) have examined the Granger causality relations between GDP, Exports and FDI among East and Southeast Asia. In their paper, the VAR and VECM of the three variables were estimated to find various Granger Causal relations for each of the eight economies and they used the fixed effects and random effects approaches to estimate the panel data VAR equations for Granger Causality tests.

Zhang (2005) examines the role of FDI on Chinese export performance. The investigation is not only the estimates of full sample of industries. The result indicates that FDI has a superior influence on export performance in China at the industrial level. Pacheco – Lopez (2005) demonstrates the causal relationship between inward FDI and export performance on Mexico by using the Granger causality test. The result indicates that there is a bi-directional causality between inward FDI and export performance. Dritsaki, Dritsaki and Adamopoulos (2004), investigates the relationship between trade, FDI and economic growth for Greece over the period 1960-2002. The co-integration analysis suggested that there is a long – run equilibrium relationship among the above variables. The results of Granger causality test showed that there is a causal relationship between the economic growth, trade and FDI.

Metwally (2004) tests the relationship between FDI, exports and economic growth in three countries, which are Egypt, Jordan and Omen, during the period from 1981 to 2000 by using 34

a simultaneous equation model. The result suggests that the export of goods and services is strongly influenced by the inward FDI in these three countries. Baliamoune – Lutz (2004) examines the causal relationship between FDI, Exports and economic growth in Morocco from 1973 to 1999 by using the Granger causality test. The result shows that there is a two – way causal relationship between FDI and exports at a national level. Alici and Ucal (2003) investigate the causal links among inward FDI, exports and economic growth in Turkish economy during the period of 1987 to 2002 on a quarter bases. The linkage of FDI –led export growth is not found in Turkey.

Frimpong and Oteng-Abayie (2008) study the causal link between FDI and GDP growth for Ghana for the pre- and post-SAP periods using Granger causality test. The test suggests identical results for the first two set periods, namely the entire block period of 1970-2002 and the pre-SAP period of 1970-1983. In both cases there was no evidence of either Growth-driven FDI or FDI-led growth. Concerning the results for the post-SAP period from 1984 to 2002, where the economy has enjoyed a relative political stability and economic focus, Frimpong and Oteng-Abayie (2008) found out evidence of FDI-led growth. Thus FDI has been improving GDP growth of Ghana. The study, however, still failed to confirm Growth-driven FDI, i.e. GDP growth in Ghana has not been attracting FDI inflows.

3.4

Concluding remarks on the literature review The empirical evidence on FDI and economic growth is ambiguous, although in theory FDI is believed to have several positive effects on the economy of the host country (such as productivity gains, technology transfers, the introduction of new processes, managerial skills and know-how, employee training) and in general, it is a significant factor in modernising the host country’s economy and promoting its growth. Especially for the 35

developing countries, the recent global changes in the 1990â&#x20AC;&#x2122;s, have led them to look favourably at the various FDIâ&#x20AC;&#x2122;s because it is believed that they can contribute to the economic development of the host country. Most of the empirical studies have found causal relationship between FDI and economic growths. This study focuses on the relationship between FDI and economic growth to examine the impact on the economy and to investigate further the effects of FDI in Ghana as a host country.

CHAPTER FOUR METHODOLOGY AND ANALYSIS OF FINDINGS 4.1

Introduction This chapter deals with the method of analysis and data collection, model specifications, description of properties of the data and model. It also contains descriptive statistics of variables, trend of FDI, and the presentation and analysis of the regression outputs.

4.2

Method of Analysis and Theoretical Framework for the model specification

4.2.1

Method of Analysis The method was mainly regression analysis involving standard ordinary least square (OLS) techniques to estimate the parametric coefficients of the explanatory variables in the econometric model based on the theoretical and empirical insights. In this study, all the assumptions of OLS estimators are assumed to be binding or true. The assumptions are that the error term is normally distributed with a mean of zero and a variance of Ď&#x192; 2. The explanatory variables are non-stochastic; the error terms have a constant variance â&#x20AC;&#x201C; this is the homoscedasticity and; successive error terms are uncorrelated i.e. there is no serial or auto correlation.

In addition, in order to know if a VECM is appropriate and to incorporate recent developments in time series modelling, the study looked beyond the traditional regression problems of autocorrelation, multicollinearity and simultaneity and considered the dynamic specification of the series and a cointegration test has to be conducted. Augmented DickeyFuller (ADF) and Phillip-Perron (PP) were used to establish stationarity to ensure that results are appropriate for policy recommendations (Charemza and Deadman, 1992). 37

Following Johansen (1988) researchers differenced through ADF and PP method to deduce the order of cointegration of their time series data. Again, on the advice of Engel and Granger (1987) on differencing, researchers reparameterised their model into an Error Correction Model (ECM) to capture possible long run information that might have been lost in the course of differencing.

E-view software version and MS excel are utilized for estimating purposes and to aid analysis of the results using the data. These are used to estimate parameters of the model chosen, alongside with other methods of analysis such as the chi square, mean, standard error, unit root and cointegration, and Granger causality test to provide numerical coefficient for each explanatory variables that are suitable for both relationship and impact analysis. However, emphasis is placed on the correlation between economic growth and foreign direct investment. This helps facilitate economic policy analysis and recommendations on the FDI.

4.2.2

Theoretical Framework This gives the theoretical foundations for the model and the main framework on which the model is based. The study predominantly adopts the study by Carkovic and Levine (2002) for time series analysis. The functional form is specified as Growth = f (FDI, CONDITIONING SET) and linearised to the basic regression which takes the form:

Where the dependable variable GROWTH equals real GDP, FDI is contribution of FDI to GDP and CONDITIONING SET represents vectors of factors other than FDI and

is error

term. Carkovic and Levine (2002) exploit the time series dimension and error correction model as follows: 38

Where

is the natural log of real GDP; X represents the set of explanatory variables other

than lagged real GDP and; is the error term and subscript t is the time period.

4.2.3

Model Specification The Keynesian macroeconomic thought has identified various factors that influence the growth of a country especially with respect to FDI as mirrored by the theoretical and analytical framework in the previous section. These factors include exchange rate, interest rate, inflation, government budget deficits, imports, exports, money supply and foreign direct investment. The model specification is a modification and extension of the models estimated at the aggregated macroeconomic level in Carkovic and Levine (2002). The model is aimed at examining the impact of the real exchange rate, inflation rate, foreign direct investment as a percentage of GDP, and openness of the economy (i.e. trade liberalisation) on economic growth. Thus, the functional relationship is given as: Economic growth = f (exchange rate, interest rate, inflation, government budget deficits, imports, exports, money supply and foreign direct investment).

The modified model adopted from Carkovic and Levine (2002) for the purpose of this study is specified as: InEGt = β0 + β1InREXt + β2InINFt + β3InFDIt +β4InOPENt + µt Where, InEGt is a measure of economic growth and InREXt is the real exchange rate, InINFt is the inflation rate, InFDIt is foreign direct investment as a percentage of GDP, InOPENt is a measure of openness of the economy (i.e. trade liberalisation) and µ t is the random error term capturing all other factors which influence economic growth but not captured in the model. 39

The error correction model (ECM) provides the means of reconciling the short-run behaviour of an economic variable with its long-run behaviour. For the purpose of the specified model, the ECM is specified as follows:

Where the , β1, β2 , β3, and β4 are representing the short-run dynamics coefficients of the model’s convergence to equilibrium and ECMt-1 is the Error Correction Model. The coefficient of Error Correction Model (p) measures the speed of adjustment to obtain equilibrium in the event of shocks to the system. The parameter β 3 is the most important parameter in this study because it measures the impact of foreign direct investment on economic growth. In order words it measures the change in economic growth as a result of a unit change in the value of Foreign Direct Investment, all things being equal.

The study uses growth rate in real Gross Domestic Product to measure economic growth i.e. EG = (GDPt - GDPt-1 )/ GDPt-1 whiles Openness (i.e. trade liberalisation) of the economy is also measured as (Exports + imports)/ GDP. Exports in this case capture exports in goods and services. The consumer price index using 1997 as the based year will be used to measure inflation.

4.3

Data Sources and Description of Variables Economic growth: There are many ways of measuring economic growth in a country. These include growth in real per capita Gross Domestic Product and growth in real Gross Domestic Product. This study however uses growth in Gross Domestic Product to measure economic growth. This measure has been chosen because it captures the salient aspect of 40

economic growth. Data on GDP was sourced from the Ghana Statistical Service to aid the regression analysis to achieve the objective of the study. Economic growth is the dependant variable in the model specification which is said to be explained by the independent variables: real exchange rate, inflation rate, share of FDI in GDP, trade liberalisation.

Real exchange rate: the real exchange rate is one of important explanatory or independent variables in the model specified to examine the impacts analysis of economic growth. The real exchange rate affects economic growth of a country in the sense that it affects the amount of goods and services that are imported and exported in a country. On the part of imports, the depreciation of the domestic currency leads to a reduction in imports while on the part of exports depreciation of the domestic currency leads to increase in exports. The net effect of the depreciation of the domestic currency is therefore an increased in net export. This enhances the availability of output of goods and services in the country hence economic growth. For this reason, the apriori expectation of the real exchange rate as explanatory variable is positive (+). That is, it is expected that there would be positive relationship between economic growth and real exchange rate in the model.

Inflation: Inflation rate is one of the explanatory or independent variables of the model. Inflation is an economic canker that every country will like to eliminate, even though, a level of inflation is needed to raise employment level. This is due to the negative consequences that it has on economic growth in an economy. High inflation leads to high cost of business, uncertainty, political instability etc. These are inimical to economic growth. It is for this reason that inflation is included in the model. Thus, it is assumed to have a negative relationship with economic growth and therefore, the apriori expectation is a negative sign (-). 41

Openness: Openness is included in the model as an explanatory variable to capture the impact of trade liberalization on economic development. Trade liberalization as argued leads to a change in the relative prices of traded and non traded goods. It is believed that the change in relative prices will induce changes in the allocation of resources to different activities and hence changes in both sub-sectoral and aggregate levels of production. These changes have the potential both to reduce poverty and increase income levels. In so doing, trade liberalization enhances economic growth.

There are many proxies that can be used to measure trade liberalization; however this study uses openness to measure trade liberalization. This measure has been chosen over other measures because it has been found that this measure captures almost every aspect of trade liberalization. In addition, it assumed that trade liberalisation has a positive relationship with economic growth and thus the apriori expectation is positive (+).

Foreign Direct Investment: The main subject of the study is centred on FDI and its impact on economic growth. Theory provides conflicting predictions concerning the growth effects of foreign direct investment. The economic rationale for offering special incentives to attract foreign direct investment frequently derives from the belief that foreign investment produces externalities in the form of technology transfers and spillovers. Romer (1993) for example argues that important â&#x20AC;&#x153;idea gapsâ&#x20AC;? between rich and poor countries exist. He noted that foreign investment can ease the transfer of technology and business know-how to poorer countries.

According to this view, foreign direct investment may boost the productivity of all firms (i.e. including those not receiving the capital). Thus transfers of technology through foreign direct investment may have substantial spillover effects for the entire economy which in turn leads to economic growth.

In contrast, some theories predict that foreign direct investment in the presence of preexisting trade, price, financial and other distortions will hurt resource allocation and slow growth in an economy (Boyd and Smith 1992). This therefore suggests that, theory produces ambiguous predictions about the growth effects of foreign direct investment. It is for this reason that foreign direct investment is included in the model as an explanatory variable so as to ascertain the growth impact of foreign direct investment. Foreign direct investment is included in the model so as to ascertain it growth impact in Ghana. The expectation sign for FDI is assumed to be positive (+) in that it is expected to lead to increase in economic growth.

Other Factors: The other factors not included in the model and errors are captured by the error term denoted by letter U.

4.4

Descriptive Statistics of the variables The summary of statistics is presented in Table 4.1. The various macroeconomic variables used for the analysis are economic growth, exchange rate, FDI as a percentage of GDP, inflation rate, inflow of FDI, import, export and GDP. The mean of the observed economic growth rate from 1970 to 2010 is 3.37%. There is 95% confidence that the mean of economic growth rate over the 41-year period falls between 1.82% and 4.93%. The mean exchange rate is 1,818.13 which is 95% confident that it falls between 1.82% and 4.93%. 43

The averages of rest of the variables are 32.89% for inflation rate, 1.5% for FDI as a percentage of GDP, US$232.94 million for annual FDI inflows, US$2427.9 million for export, US$1616.22 million for imports, 0.393 for trade liberation ratio, and 17,287.24 for GDP.

Table 4.1: Summary of statistics

4.5

Variable

Observation Mean

Std. Err.

95% Confidence Interval

GDP growth

3.377805

0.769223

1.823148

4.932462

Real exchange

1818.132

493.5344

820.6615

2815.602

Inflation

32.88976

4.590574

23.61186

42.16765

FDI/GDP

0.0150293

0.002835

0.0093004

0.0207581

FDI

232.942

78.68311

73.91746

391.9664

Import

2427.895

473.6053

1470.703

3385.087

Export

1616.216

302.0974

1005.655

2226.778

Openness

0.3934146

0.037977

0.3166598

0.4701695

GDP

17287.24

7521.722

2085.271

32489.21

Trend of FDI Figure 1 shows trend of inflow of FDI in Ghana over a forty-one-year period. The average FDI inflow over the period from 1970 to 2010 was US$232.94 million. In 1970, the recorded inflow of FDI was US$68.00 million which dropped by 55% the following year (1971) to US$30.60 million. Inflow of FDI continued to fall sharply by 62% to US$11.50 million in 1972 and kept fluctuating during the 41-year period. In 1977, inflow of FDI was the highest with 1820% increase to from 1 million to US$19.2 million. 44

From observation in Figure 1, inflow of FDI picked up after the passage of GIPC Law 1994. For instance, inflow increased by 30% from US$150.27 million in 1995 to US$194.9 million in 1996 and increased by 143% to US$474.58 million in 1997. In 2000, foreign investment dropped by 49% due to uncertainties of the election year. However, foreign investment picked up again from 2004 and continued to increase due to the improvement in the political stability and macroeconomic variables until 2010 where the maximum inflow was realised due to the exploration of oil fines in Ghana. Figure 4.1 : Trends of FDI from 1970 to 2010 3000000

FDI inflow '000' US$

2500000

2000000

1500000

1000000

500000

Source: scattered documents from UNCTAD reports, ISSER reports, Bank of Ghana, IMF and World Bank and GSS

4.6

Trends of Economic Growth The economic growth rate from 1970 to 2010 is presented in Figure 2. As can be observed, the economy suffered in the 1970s and mid 1980s. During these periods, the economy of Ghana experienced negative growth rate in some years. For instance, growth rate was negative 2.5% in 1972, negative 12.9% in 1975, negative 3.5% in 1976 and negative 7.8% in 1979, negative 3.5% and negative 5.6% in 1983. However, economic growth became relatively stable from 1985 and continued with positive GDP rates up to 2010. The average GDP growth rate during the 41-year period was 3.38%. The highest GDP growth rate was 15.3% in 1973 whist the worst GDP growth rate of negative 12.9% happened in 1975. In 1988, the economy experienced growth rate of 6.2% which increased at a decreasing rate of 3.3% in 1990. The GDP growth increased from 3.8% in 1994 to 7.2% in 2008.

Figure 4.2: Trends of GDP growth from 1970 to 2010 20.00

15.00

Growth rate (%)

10.00

5.00

0.00

-5.00

-10.00

-15.00

Source: scattered documents from UNCTAD reports, ISSER reports, Bank of Ghana, IMF and World Bank and GSS

4.7

The Time Series Properties of the Variables This section considers brief discussion on time series characteristics such as the unit root test, cointegration test as vector error correction model which are shown below:

4.7.1

Unit root test To avoid spurious results, unit root tests of augmented Dickey-Fuller (ADF) (Dickey and Fuller, 1979) and Phillip-Perron (PP) (Phillips-Perron, 1988) were performed at both level and difference to determine the time-series properties of the data employed in the analysis. The results of the ADF unit root tests at level and difference are presented in Table 4.2 and Table 4.3. Similarly, the results of the Phillips-Paerron unit root tests at level and difference are presented in Table 4.4 and Table 4.5 respectively.

Table 4.2: Result of ADF Unit Root Test of variables at their levels variable

t-statistic

1% Critical Value*

5% Critical Value

10% Critical Value

lnEG

-3.28655

-3.6067

-2.9378

-2.6069

lnREX

-1.45538

-3.6067

-2.9378

-2.6069

lnINF

-2.6450

-3.6067

-2.9378

-2.6069

lnFDI

-0.89114

-3.6067

-2.9378

-2.6069

lnOPEN

-2.60907

-3.6067

-2.9378

-2.6069

*MacKinnon critical values for rejection of hypothesis of a unit root.

Table 4.3: Result of ADF Unit Root Test of variables at their difference variable

t-statistic 1% Critical Value*

5% Critical Value

10% Critical Value

lnEG

-7.34936

-3.6117

-2.9399

-2.608

lnREX

-4.16719

-3.6117

-2.9399

-2.608

lnINF

-6.20018

-3.6117

-2.9399

-2.608

lnFDI

-6.97286

-3.6117

-2.9399

-2.608

lnOPEN

-5.73264

-3.6117

-2.9399

-2.608

*MacKinnon critical values for rejection of hypothesis of a unit root.

Table 4.4: Results of Philip-Perron Unit Root Test of variables at their levels variable

t-statistic

1% Critical Value*

5% Critical Value

10% Critical Value

lnEG

-5.28195

-3.6019

-2.9358

-2.6059

lnREX

-1.51826

-3.6019

-2.9358

-2.6059

lnINF

-3.95009

-3.6019

-2.9358

-2.6059

lnFDI

-1.83913

-3.6019

-2.9358

-2.6059

lnOPEN

-3.19999

-3.6019

-2.9358

-2.6059

*MacKinnon critical values for rejection of hypothesis of a unit root.

Table 4.5: Results of Philip-Perron Unit Root Test of variables at their difference variable

t-statistic 1% Critical Value*

5% Critical Value

10% Critical Value

lnEG

-13.5532

-3.6067

-2.9378

-2.6069

lnREX

-6.14888

-3.6067

-2.9378

-2.6069

lnINF

-11.5366

-3.6067

-2.9378

-2.6069 48

lnFDI

-10.9017

-3.6067

-2.9378

-2.6069

lnOPEN

-8.33266

-3.6067

-2.9378

-2.6069

*MacKinnon critical values for rejection of hypothesis of a unit root.

The ADF and Phillip-Perron tests have a null of unit root against the alternative of trend stationary. The more negative the test statistic the stronger the rejection of the hypothesis that there is a unit root at 1%, 5% or 10% level of significance. The unit root test using ADF at level reveals that all the variables are non-stationary except the natural log of real GDP or economic growth (lnEG) at 1%, 5% and 10% levels of significance (Table 4.2). The PP tests presented in Table 4.4 was computed at level which shows that only natural log of real GDP (lnEG) and inflation (lnINF) are statistically significant among the variables since they were rejected at at 1%, 5% and 10% levels of significance whilst lnOPEN was rejected at 5% and 10% significant levels. However, the ADF and PP tests at their first difference indicates that all the variables were rejected at 1%, 5% and 10% since the t-statistics in absolute terms are greater than the critical values. Given that both the Augmented Dickey Fuller and Phillip -Perron tests are superior at their first differences, the study proceeds to use the test results as the basis for investigating co-integration relationship between the variables.

4.7.2

Co-integration test The regression model shows a relationship between the economic growth and the determinants, that lnREX, lnINF, lnFDI and lnOPEN. The tests of such a regression may often suggest a statistically significant relationship between these variables where none in fact exists. Thus, co-integration test is conducted to find or to determine whether a group of non â&#x20AC;&#x201C; stationary series is co-integrated or not. That is, test is conducted on the series of 49

lnEG, lnREX, lnINF, lnFDI and lnOPEN and observed the values of the t-statistics of the coefficient estimates calculated under the assumption that the true value of the coefficient equals zero as suggested by Granger and Newbold (1974).

Table 4.6: Results of Johansen co-integration test Likelihood

5% Critical

1% Critical

Hypothesized

Eigenvalue

Ratio

Value

No. of CE(s)

0.799703

173.1208

68.52

76.07

None **

0.720678

112.0186

47.21

54.46

At most 1 **

0.600826

63.55379

29.68

35.65

At most 2 **

0.357209

28.65621

15.41

20.04

At most 3 **

0.268146

11.86263

3.76

6.65

At most 4 **

*(**) denotes rejection of the hypothesis at 5%(1%) significance level. L.R. test indicates 5 cointegrating equation(s) at 5% significance level

The study investigates the possible co-integrating relationship(s) between variables in economic growth function that was specified. Two or more variables are said to be cointegrated, i.e., they exhibit long-run equilibrium relationships, if they share common trends. The co-integration among variables rules out the possibility of the estimated relationships being â&#x20AC;&#x153;spuriousâ&#x20AC;?. The study adopts the Johansen test procedure for testing for co-integration relationship between economic growth and key determinants such as the exchange rate, inflation rate, ratio of FDI to GDP, and the trade liberalization. To accept the null hypothesis, the calculated test statistics must be smaller than their associated critical values. Based on the Eigen-value and Likelihood Ratio and their corresponding critical values, the null hypothesis of no co-integration between the economic growth and key determinants of 50

interest are rejected at 1% level of significance, while the hypothesis that there is at most (1) co-integrating equation was rejected at the 5% significance level. The results confirm the existence of an underlying long-run stationary steady-state relationship between the economic growth and the explanatory variables. Given that there is at least one cointegrating vector in the model, the equation can be estimated in levels. The variables of the model appear to share a long-run equilibrium relationship. So that, over long period of time the variables will not move independently of each other but rather are linked in the long-run.

4.8

Analysis of findings of the regression results

4.8.1

Long Run Growth relationship of Cointegration Equation The result of the regression result presented in Table 4.7 shows the long run relationship between dependent variable, economic growth (InEG) and the explanatory variables, that is, real exchange rate (InREX), annual inflation rate (InINF), FDI contribution to GDP (InFDI) and trade liberalisation or openness to external trade (InOPEN). The result of the conitnegration regression for long run coefficients shows that all the key determinants or explanatory variables are statistically significant at 1% level of significance since their pvalues are zero which are less than the 0.01 probability except real exchange rate (InREX) which is not rejected because the p-value is greater than probability at 5% and 10% significant levels. In the long run, the effects of the explanatory variables based on their elasticities on economic growth are that, a percentage increase in the annual exchange rate would cause economic growth to fall by about percentage at 3.4%. A percentage increase in the annual inflation rate would cause economic growth to rise by about 123% and a one percentage increase in contribution of FDI to GDP would increase economic growth by about 187% whilst an increase in openness or liberalisation ratio would lead to 128% decline in real GDP or economic growth. The long run relationship between economic 51

growth and contribution of FDI to GDP is more favourable according to the conintegration results of the equation. This implies that, in the long run when FDI inflow increases, its contribution to GDP will increase which in turn will increase economic growth through increased in real GDP. Increase in FDI inflow will increase investment which in turn will increase aggregate expenditure and thus increase aggregate demand. Increase in aggregate demand will GDP and thus leads to higher economic growth.

Table 4.7: Results of the long-run Coefficients of Cointegration Equation Variable

Parameter

Coefficient

Std. Error

P>z

lnREX

β1

-0.03394

0.115554

-0.29

0.769

ln INF

β2

1.225578

0.290099

4.22

0.000

ln FDI

β3

1.871599

0.219572

8.52

0.000

ln OPEN

β4

-1.27663

0.235399

-5.42

0.000

-0.11412

Constant

As noted already, the coefficient of real exchange rate was found to be -0.0339 and is statistically insignificant at 1%, 5% and 10% significance levels. Thus, a percentage increase in real exchange rate causes real GDP growth to decline by approximately 3.4%. This is quite implausible since it is expected that real exchange rate enhances terms of trade make domestic produced items competitive in international trade and hence economic growth. The coefficient of FDI as contribution to GDP in the long run growth equation is positive and significant at %1 significance level. The sign of the FDI GDP ratio variable supports the theoretical conclusion that FDI inflow contributes positively to real GDP growth. When ratio of FDI to GDP goes up by 1% real GDP growth goes up by 187%.

Inflation has a positive coefficient of 1.2256 and has significant impact on real GDP growth since it is statistically different from zero at both 1% levels of significance. The results in Table 4.7 indicate that when inflation goes up by 1 percent, real GDP growth also goes up by approximately 123%. It is expected that a rise in inflation raises the cost of borrowing which lowers the rate of capital investment and thus reduces output growth. However, the results obtained here indicate the reverse. But other studies have found results similar to what has been obtained here. Khan and Senhadji (2001) have argued that inflation per se is not harmful to growth. Their study suggested that there is a threshold beyond which inflation is harmful to growth (i.e. inflation negatively affects economic growth). Additionally, it can be said that when inflation is creeping it is not harmful to growth. The positive relationship between inflation and GDP growth obtained in this study is consistent with the structuralist believe that inflation is essential for economic growth. It is also consistent with the findings of Girijasankar and Chowdhury (2001) who also found a similar long run positive relationship between inflation and GDP growth in four Asian countries namely, Bangladesh, India, Pakistan and Sri Lanka. The coefficient of openness (trade liberalisation) expressed as a ratio sum of import and export to GDP was found to be 1.2766 but significant at 1 percent significance level. Thus, a percentage increase in openness reduces real GDP growth by approximately 128%. This is quite implausible since it is expected that openness enhances competition and efficiency as well as transfer of technology and knowledge and hence economic growth.

4.8.2

Vector Error Correction Model (VECM) Table 4.8 presents estimate of the conditional VECM using ordinary least square in order to test for the presence of short run relationship among the variables. This is done by conducting an F-test for the joint significance of the coefficients of lagged levels of the 53

variables. Thus, each of the variables in the model is taken as a dependent variable and a regression is run on the others. For instance, economic growth (D(LNEG)) is taken as the dependent variable and it is regressed on the other variables. The results show that, there is the existence of cointegration among the variables in the economic growth equation.

Table 4.8 reports the results of the VECM which shows short-run dynamic economic growth equation in the column marked D(LNEG). Generally, the Error Correction Model (ECM) is estimated by VECM providing the means of reconciling the short run behaviour of an economic variable with its long-run behaviour. The existence of cointegration relationships among the variables implies the estimation of Error Correction Model to determine the dynamic behaviour of the economic growth equation. The Error Correction Model captures the short run dynamics of the system and its coefficient of negative 0.4167 (41.8%) measures the speed of adjustment to obtain equilibrium in the event of shocks to the system. There is a relationship between the variables, that is, any short run disequilibrium in the relationship will revert to equilibrium. The result also suggests in the short run change in variables have significant impact on economic growth.

Table 4.8: Results of Vector Error Correction Model (VECM) Error Correction: CointEq1

D(LNEG(-1))

D(LNREX(-1))

D(LNINF(-1))

D(LNEG) -0.41672 -0.12491 (-3.33632) -0.5712 -0.1547 (-3.69229) -0.05001 -0.07537 (-0.66347) 0.171561 -0.17043 -1.00664

D(LNREX) 0.156601 -0.24395 -0.64194 0.054002 -0.30214 -0.17873 -0.53744 -0.14721 (-3.65083) -0.07698 -0.33286 (-0.23126)

D(LNINF) -0.19746 -0.13296 (-1.48510) 0.336031 -0.16467 -2.04057 -0.05538 -0.08023 (-0.69018) -0.45469 -0.18142 (-2.50629)

D(LNFDI) -0.90826 -0.12662 (-7.17309) 0.608575 -0.15682 -3.8806 -0.02973 -0.07641 (-0.38909) 0.773899 -0.17277 -4.47933

D(LNOPEN) -0.04187 -0.16058 (-0.26071) 0.172747 -0.19888 -0.86859 -0.03073 -0.0969 (-0.31713) -0.11964 -0.2191 (-0.54603) 54

D(LNFDI(-1))

D(LNOPEN(-1))

R-squared Adj. R-squared Sum sq. Resids S.E. equation F-statistic Log likelihood Akaike AIC Schwarz SC Mean dependent S.D. dependent

0.419104 -0.27803 0.112454 0.06023 -0.14692 -0.28695 -0.1564 -0.14894 -2.85253 (-0.96889) -0.71903 -0.40439 -0.27954 0.499919 -0.07106 -0.65351 -0.1494 -0.2918 -0.15904 -0.15146 (-1.87103) -1.71324 (-0.44683) (-4.31480) 0.635334 0.338205 0.594175 0.808617 0.578355 0.2348 0.530765 0.778714 32.8362 125.2538 37.20735 33.74454 1.012981 1.978429 1.078299 1.026897 11.15033 3.270672 9.370354 27.04084 -51.1446 -76.582 -53.5192 -51.6631 3.007612 4.346422 3.132587 3.034899 3.266178 4.604989 3.391153 3.293465 0.050224 -0.00621 -0.05075 0.026655 1.560013 2.261689 1.574143 2.182979 Standard error and t-statistics are in parenthesis

0.018065 -0.18888 -0.09564 -0.49481 -0.19207 (-2.57611) 0.379892 0.283 54.27066 1.30229 3.920778 -60.6912 3.510064 3.76863 -0.00865 1.53797

The VECM in Table 4.8 shows OLS regression of economic growth as dependent variable on the real exchange rate, inflation rate, ratio of FDI to GDP, and openness. The coefficients of variables indicate the short-run elasticities and the apriori expectations are not different from the long run variables. The coefficient of ECM, economic growth, ratio of FDI to GDP and openness are statistically significant at 5% level of significance. However, real exchange rate and inflation rate are statistically not significant at 5% level of significance. That is in the short run, both real exchange rate and inflation are statistically not different from zero and thus do not affect economic growth.

The overall regression is significant at 5% as can be seen from the R-squared and the Fstatistic. R-squared value of 0.6353 indicates that about 63.53% of the change in the dependent variable, economic growth (DLNEG) is explained by changes in the independent variables. Also, an F-statistic value of 11.150 suggests the joint significance of the determinants in the short run cointegration equation. 55

In addition, the results show that in the short run a percentage increase in real exchange rate would cause economic growth to reduce by 5%. Ideally, devaluation of Ghanaâ&#x20AC;&#x2122;s currency is make exportable products cheaper in the eyes of foreigners so that more of domestic products can be exported. But devaluation in Ghanaâ&#x20AC;&#x2122;s currency over the 41 -year period did to increase export much since exports are mainly limited to few primary products. Ghana has always being a net import and this has had negative impact on economic growth. A percentage increase in inflation would cause about 17% increase economic growth in the short run. This implies that some level of inflation (which is a measure of macroeconomic instability) is required for growth both in the long run and in the short run since a rise in inflation raises GDP growth.

The VECM in Table 4.8 also shows a percentage increase in ratio of FDI to GDP would increase economic growth by 25.8%. In the short run, contribution of FDI to GDP is enhancing economic growth due to FDI flowed from developed countries to Ghana through multinationals especially in the mining and oil sector.

A percentage increase in openness ratio would decrease economic growth by about 28%. This shows that in the short run, openness of trade (trade liberalization) could be detrimental to growth in Ghana. The negative contribution of trade to growth in the short run may be due to the unfavourable terms of trade. The exports of Ghana are mainly raw primary products which experience fluctuating prices while the prices of her imports which are mainly consumables are rising, thus creating unfavourable terms of trade. In addition, the unfair competition on some of the sectors of the economy such as the textiles, poultry, and rice that results from trade liberalization could explain the negative impact of trade openness on GDP growth. In the short run, some of the domestic sectors of the economy are not able 56

to compete more favourably with their more efficient counterparts of the advanced countries. This is usually because most of the domestic industries are infant industries which produce at a relatively higher average cost.

4.9

Causality test between FDI and Economic Growth In doing economic analysis such as the impact of FDI on the economic growth, it is important to know whether changes in a variable will have an impact on changes in other variables. It is to be noted that, this study focuses attention of FDI as opposed to others. To find out this phenomenon more accurately, the study conducted Pairwise Granger causality tests and their results are presented in Table 4.9.

Table 4.9: Results of Pairwise Granger Causality Tests Null Hypothesis:

F-Statistic

Probability

LNREX does not Granger Cause LNEG

0.54823

0.58314

LNEG does not Granger Cause LNREX

0.09246

0.91192

LNINF does not Granger Cause LNEG

0.06069

0.94122

LNEG does not Granger Cause LNINF

1.49562

0.23891

LNFDI does not Granger Cause LNEG

2.38773

0.10753

LNEG does not Granger Cause LNFDI

2.5019

0.09735

LNOPEN does not Granger Cause LNEG

1.45501

0.24798

LNEG does not Granger Cause LNOPEN

2.13046

0.13483

LNFDI does not Granger Cause LNREX

0.49754

0.61251

LNREX does not Granger Cause LNFDI

0.03211

0.96843

LNFDI does not Granger Cause LNINF

0.16857

0.8456 57

LNINF does not Granger Cause LNFDI

7.58245

0.00195

LNOPEN does not Granger Cause LNFDI

1.83807

0.17504

LNFDI does not Granger Cause LNOPEN

0.19315

0.82528

From test of the Granger causality, one can realise that there is relationship or causality among economic growth and some variables whilst no causality exist between others. The null hypothesis that FDI does not Granger cause economic growth is not rejected since the F-test statistic of 2.38773 is less than the critical F-value of 2.5019 (Table 4.9). This implies that FDI does not influence the economic growth. However, FDI Granger causes real exchange rate whilst openness of the economy Granger causes FDI. Thus, liberalisation influences and attracts FDI as stated by theory. The results in Table 4.10 also indicates that trade openness does not influence economic growth since the F-statistic of 1.45501 is less than the critical F-value of 2.13046.

CHAPTER FIVE SUMMARY, CONCLUSIONS AND POLICY RECOMMENDATIONS 5.1

Summary and conclusion Foreign Direct Investment (FDI) has been identified as one of the sources of long term investment that could guarantee long term economic growth and eventually transform developing economies into middle-income economies. The impact of FDI on the receiving country may be varied, though its positive contribution to resource availability, capital formation, transfer of managerial and organizational practices, skills and technology and access to international market networks cannot be over emphasized, the host countryâ&#x20AC;&#x2122;s ability to take advantage of all these benefits of FDI depends to a large extend on the openness of the country, business environment, political and economic stability and a host of other factors.

The role played by FDI in developing countries has been an attractive subject for many theoretical and empirical studies. However, there are still inconclusive arguments in relation to the impact of FDI on economic growth. The problem is that it is uncertain whether FDI actual increase economic growth in Ghana and based on this, the question as to whether massive inflow of foreign direct investment into Ghana had a positive impact on growth in Ghana needs to be investigate.

Consistent with the statement of problem, the broad objective of this study was to examine the impact of FDI on Economic Growth in Ghana using data from 1970-2010. In order to achieve this broad objective of the thesis, the following specific objectives are to be pursued. These are to examine the impact of FDI on economic growth in Ghana i.e. to ascertain whether there exist a positive relationship between foreign direct investment and 59

economic growth; to examine the trends in both FDI and economic growth in Ghana and; to make recommendations to policies makers on the effects of FDI and economic growth policies on the country. In order to achieve the stated objectives, the study seeks to test the null hypothesis that, H0: foreign direct investment has no impact on economic growth in Ghana against the alternative hypothesis that, H1: foreign direct investment has positive impact on economic growth in Ghana.

The findings show that, generally, the trend of FDI inflows in Ghana kept fluctuating during the 41-year period from 1970 to 2010. The inflow of FDI picked up after the passage of GIPC Law 1994. The fluctuations in FDI inflows may be attributed to the coup dâ&#x20AC;&#x2122;ĂŠtats and political instabilities that occurred between 1970 and 1993 as well as election years between the period of 1993 and 2008. The trends in economic growth (real GDP growth) during the period 1970 - 2010 indicate that the economy suffered in the 1970s and mid 1980s. During these periods, the economy of Ghana experienced negative growth rate in some years. However, economic growth became relatively stable from 1985 and continued with positive GDP rates up to 2010. The variables of the model appear to share a long-run equilibrium relationship. So that, over long period of time the variables will not move independently of each other but rather are linked in the long-run.

Furthermore, the findings of time series properties indicates that there is contegration among the variables and the model correctly predicts relationship between economic growth and the key determinants of real exchange rate, inflation, contribution of FDI to GDP and openness of the economy. From the economic growth model used, a unit contribution of FDI would increase investment which in turns increases GDP and thus leads to higher economic growth. Moreover, there is relationship or causality among the FDI and economic 60

growth as well as between FDI and other variables such as real exchange rate, inflation and openness of the economy were interesting. FDI has no influence on economic growth.

5.2

Policy recommendations The effects of FDI are at the centre of a continuing controversy in the economic transformation of Ghana. Many Ghanaian economists believe that the impact of such investment is positive, since it brings to the country a package of capital, foreign exchange, technology, managerial expertise, skills, and other inputs typically in short supply locally. From the analysis, it can be argued that FDI and participation in the global market might bring about a higher economic growth rate through employment creation, income distribution and technological transfer. In the 1970s and 1980s, Ghana became heavily indebted and, finding it difficult to raise new foreign loans to mobilize domestic resources, FDI looked increasingly attractive, not as an additional source of capital but for the technology and market access such investment brings.

It follows therefore that a lot of effort ought to be made in order to attract FDI in Ghana, which has a high potential of creating the necessary linkages between the various sectors of the economy. By this, the poverty reducing effect of FDI can be effectively realized since lots of jobs could be created and many who get jobs increase their income and pay income taxes to government. At the sectoral level, the problem of poor infrastructure has been compounded by inappropriate sector specific policies, which does not create the required incentives for investors. This among other constrains further strengthens the case on the need for the government to intensify its efforts at improving the socio-economic infrastructure which will eventually cast the economy as the destination with costminimising features suitable for FDI. 61

Furthermore, the vigour with which the privatisation programme is being carried out by past government has to be maintained. It is only when the government shows so much commitment in the privatisation process that investors will have the confidence that government believe in the private sector and willing to accord it a proper place in the national economic policy framework. Domestic investors must also be given the necessary attention as their foreign counterparts. Most often than not, domestic investors are not given the necessary attention because they are perceived as lacking the necessary capital and expertise to undertake the kind of investment that is undertaken by their foreign counterparts. It is however, high time we took a critical look at this issue by given them the necessary support to ensure their growth and sustenance. Investments by domestic investors carry some advantages, which foreign investors may lack. While foreign investors always think of repatriating profits back to their home countries, domestic investors keep theirs in the domestic economy and thereby improving on the foreign reserve base of the economy. They also employ the local population from management to labourers and as such do not have to pay huge expatriate fees in hard currencies.

Moreover, various issues that are contained in the investment laws must be all inclusive and properly implemented to capture the advantages of investing in Ghana. For instance, it can be shown that it is cheaper investing in lower cost of doing business economies in Africa which involve labour costs, electricity, water, telecommunication and other overhead cost that can be improved by government actions.

In addition, the government, through the Ghana Investment Promotion Centre (GIPC), should work out measures to ensure continued market-oriented reforms that will make it 62

possible to narrow the gap between Ghana and its main competitors. Ghana would be better off if it encouraged manufacturing, agricultural, and industrial sector activities together with the rapid development of service sector activities. This will promote local private-sector initiatives and employment. There is a lack of information on the opportunities available in the country for foreign investors. The drive to attract FDI should be gradual and needs to be accompanied by some form of industrial upgrading, based on a careful assessment of which activities are fit to be exposed to international competition in the global market.

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