The drying up in the early 1980’s of commercial bank lending to developing economies made most countries eased restriction on foreign direct investment (FDI) and many aggressively offered tax incentives and subsidies to attract foreign capital (Aitken and Harrison, 1999). Private capital flow to emerging market economies reached almost $200 billion in 2000. This is almost four times larger than the peak commercial bank lending years of the 1970’s and early 80’s. FDI now accounts for over sixty percent of private capital flow (Levine and Carkovic, 2002). However, while the explosion of FDI flow remains unmistakable, the growth effect remains unclear.
Foreign direct investment (FDI) has been a topic high on the policy agenda in emerging markets. This is due to the contributions FDI make to a country’s external financing and economic growth. The extent of regulation of FDI and other form of capital flow are also issues policymakers take a stand on and economic research has devoted a large effort to these issues. The experience of small number of fast-growing East Asian newly industrialized economies (NIEs), and recently china, has strengthened the belief that attracting FDI is needed to bridging the resource gap of low-income countries and avoiding further build-up of debt while directly tackling the cause of poverty (UNCTAD, 2005).
Even though the Asian crisis sounded a cautionary note to premature financial liberalization the call for more accelerated pace of opening up FDI have intensified on the assumption that this will bring not only more stable capital inflow but also greater technological know-how, higher paying jobs, entrepreneurial and workplace skills and new export opportunities (Prasad et al., 2003).
The increased importance of FDI has brought about international relationships, trade and policies materializing into export and imports between nations. This in turn results financial rewards to host countries. Policy makers across the region of Africa have hoped that attracting FDI with the bait of high tariff protection and generous incentives packages would provide the catalyst for a “late industrialization” drive (Thandika, 2001).
The debt crises in the early 80’s and policies introduced by several countries in Africa also witnessed increased FDI as necessary for economic development. The pursuit of responsible macroeconomic policies combined with an accelerating pace of liberalization, deregulation and above all privatization were expected to attract FDI to Africa (WorldBank, 1997). However, the record of the past two decades with respect to reducing poverty and attracting FDI as a result of policy changes has been disappointing at best (Ayanwale, 2007).
The importance of FDI varies across different sector in the recipient countries. However, in all major country groups, the extractive sector accounts for a significant share of inflow of FDI: for example, Australia, Canada and Norway among developed countries; Botswana, Nigeria and South Africa in Africa; Bolivia, Chile, Ecuador and Venezuela in Latin America and the Caribbean; and Kazakhstan in South-East Europe and the CIS (UNCTAD, 2006a).
The important of this sector is due to the fact that oil and gas are crucial to the contemporary global economy and their prices are key components of economic forecasts and performance. Crude oil and refined petroleum products constitute the largest single item in international trade, whether measured by volume or value (Steven, 2005). Thus, oil and gas are strategic resources in national, regional and global economies.
Despite this significant and strategic influence, empirical evidence suggests that oil and gas abundant economies are among the least growing economies (Sachs and Warner, 1997, Gelb, 1988, Stevens, 1991, Steven, 2005). This phenomenon is often conceived within the prisms of the “resource curse” and “Dutch disease”. Both of which are manifestations of inefficient utilization of resources rather than the inevitable outcome of the availability of oil and gas resources. The impact of FDI on economic growth of recipient country has been one of varying opinions among authors.
A huge literature exists concerning different effects of foreign investment on economic development in a recipient economy. Currently FDI sustains the most dynamic development in the world economy in comparison with other forms of foreign financing (De Gregorio, 1992). Most theoretical and empirical findings (see chapter 3) imply that FDI has a strong positive growth impact on the recipient economy.
Within the African context, the Nigerian economy is a unique case, not because it is a developing economy and is quite large, but because during last 15 years the country has not managed to attract significant amounts of FDI (Asiedu, 2002). Typically investment risks are so high in Nigeria that only high profits in export oriented extractive industries (e.g. fuel industry) have attracted much foreign direct investment. This sector exerts a prominent influence on the economy as a key revenue earner. While oil and gas resources have very high revenue yields due to increasing international demand the question of aggregate FDI impact on economic growth remains an open question. This paper attempts to find some answers.
Over the last decade, the Atlantic Ocean off the coast of Western and Southern Africa has become one of the most promising oil exploration areas in the world with a convergence of interest between African governments, multinational oil companies, international Financial Institutions (Jerome et al., 2007). Nigeria falls among the six countries which have become key players in the world of energy stake. However, the economic record and lived experience of mineral-exporting countries has generally been disappointing.
The World Bank classification of Highly Indebted Poor Countries include: twelve of the world 25 most mineral dependent states and six most oil dependent. When taken as a group, all “petroleum rich” less developed countries has witnessed erosion in their living standards and many rank bottom one-third of United Nations Human Development Index. In addition to poor growth records and entrenched poverty, they are also characterized by high level of corruption and a low prevalence of democratization (Jerome et al., 2007).”
1.2 FDI Defined
Various classifications have been made of foreign direct investment. For instance, FDI has been described by the Balance of Payment Manual 5th edition (BPM5) as a category of international investment that reflects the objective of a resident in one economy (the direct Investor) obtaining a lasting interest of a resident in another economy (the direct investment enterprise). The lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence by the investor on the management of the enterprise.
A direct investment relationship is established when the direct investor has acquired 10 percent or more of the ordinary shares or voting power of an enterprise abroad (IMF, 1993). This comprises not only the initial transaction establishing the FDI relationship between the direct investor and the direct investment enterprise but all subsequent capital transactions between them and among affiliated enterprises resident in different economies (Patterson et al., 2004). Once a firm undertakes FDI, it becomes a multinational enterprise (MNEs).
Policymakers believe that foreign direct investment produces positive effects on host economies. Some of these benefits are in the form of externalities and the adoption of foreign technology which could be in the form of licensing, agreements, imitation, employee training and the introduction of new processes by the foreign firms (Alfaro et al., 2004). Multinational enterprises are said to diffuse technology and management know-how to domestic firms (Tang et al., 2008).
FDI is conventionally used as a proxy to measure the extent and direction of MNE activities (Jones, 1996). Like any other business, MNEs have a major objective of maximizing profit and reducing costs. Hence, MNEs consider regions with higher returns on investment and enabling environment for business success. This is one of the reasons for more FDI in some places than others. Accordingly MNE will invest higher in regions that provide the best mix of the traditional FDI determinants (Berg, 2003). The motivation for investment by multinationals in certain countries much more than others is discussed elaborately in chapter three
The involvement of MNEs (through FDI) in extractive industries has had a chequered history. In the early twentieth century, these industries accounted for the largest share of FDI, reflecting the international expansion of firms from the colonial powers. With a growing number of former colonies gaining independence after the Second World War, and the creation of the Organization of the Petroleum Exporting Countries (OPEC) in 1960, the dominance of these MNEs s declined, as did the share of extractive industries in global FDI.
From the mid-1970s, in particular, the share of oil, gas and metal mining in world FDI fell steadily as other sectors grew much faster. However, as a result of rising mineral prices, the share of extractive industries in global FDI has recently increased, although it is still much lower than those of services and manufacturing. It is therefore an opportune timeto revisit the impact of FDI into theextractive industries has on economic development.
Measuring the effect of FDI on economic growth occupies a substantial body of economic literature. Many theoretical and empirical studies have identified several channels through which FDI may positively or negatively affect economic growth (Akinlo, 2003, Mello, 1997). Not many studies have reported on the effects of FDI in Africa and most existing studies have concentrated on economies with high FDI in the manufacturing industries unlike economies with high FDI inflow in the extractive sector (as the case of Nigeria).
Several factors suggest that the indirect benefits of FDI maybe less in extractive sector especially oil industries. Reasons given for this are that: firstly, the extractive sector (such as oil sub-sector) is often an enclave sector with little linkages with the other sectors. Secondly, the knowledge and technology embedded in the sector is extremely capital intensive and so transfer of knowledge and technology maybe less. Also, the capital requirement and large economies of scale may not attract new entrants into the sector as in the manufacturing sector. Furthermore, not all sector of the economy have the same potential to absorb foreign technology or create linkages with the rest of the economy (Hirschman, 1958). Finally, sales in this sector are foreign market oriented and require fewer input of materials and intermediate goods from local suppliers. Hence will have less forward and backward linkages (Akinlo, 2004). The sensitivity of project to world commodity price also make it been view as a volatie sector (WorldBank, 2005)
Given the pattern of foreign direct investment flow to Nigeria (mostly in oil and gas sector) and the angst-ridden as regards the benefits from the extractive FDI, it is apposite to examine empirically the situation in Nigeria. This constitutes the objective of this research. An analysis of this will be done for the period between 1980 and 2006
1.4 Overview of Foreign Direct Investment
1.5 Natural Resources and Economic Development
Since the 1950’s, economists have been concerned that economies dominated by natural resources would somehow be disadvantaged in the drive for economic progress. In the 1950’s and 1960’s, this concern was based upon deteriorating terms of trade between the “centre” and “periphery” (Prebisch, 1964) coupled with concern over the limited economic linkages from primary product exports to the rest of the economy (Hirschman, 1958). In the 1970’s, it was driven by the impact of the oil shocks on the oil exporting countries (Wijnbergen and Van, 1986, Mabro and Monroe, 1974).
In the 1980’s, the phenomenon of “Dutch Disease” (the impact of an overvalued exchange rate on the non-resource traded sector) attracted attention (Corden, 1984). Finally in the 1990’s, it was the impact of revenues from oil, gas and mineral projects on government behaviour that dominated the discussion (Stevens, 1991, Gelb, 1988).
The common thread running through these concerns is that the development of natural resources should generate revenues to translate into economic growth and development. Thus the revenues accruing to the economies should provide capital in the form of foreign exchange overcoming what was seen as a key barrier to economic progress. This could be explained both in terms of common sense (more money means a better standard of life) and development theories – the requirement for a “big-push” (Murphy et al., 1989), capital constraints (Lewis, 1955, Rostow, 1960) and dual-gap analysis (Shibley and thirlwall, 1981).
However, the reality appeared to be the reverse. Countries with abundant natural resources appeared to perform less well than their more poorly endowed neighbors. Thus the term “resource curse” began to enter the literature (Vanderlinde, 1994). More recently there has been a revival of interest in the phenomenon of “resource curse”. Furthermore, this has drawn the attention of a much wider audience than previously.
Growing concern among a number of non-governmental organizations (NGO’s) regarding the negative effects of oil, gas and mineral projects on developing countries has had several effects. It has forced the World Bank group to consider their role in such projects. This has culminated in the creation of “the Extractive Industry Review” based in Jakarta to consider whether the World Bank Group should, as a matter of principle, have any involvement with such projects. Disagreement within and between the World Bank and the IMF have further fuelled the debate over how such revenues should be managed.
NGO concern has also encouraged the more responsible petroleum and mineral corporations to consider the impact of their investment in such projects on the countries concerned. However, in the literature that has focused on “resource curse”, there are references to countries that allegedly managed to avoid a “curse” and instead received a “blessing”. For example, even the report produced by Oxfam America (Ross, 2001) which is strongly negative towards such projects, states … “There are exceptions: some states with large extractive industries – like Botswana, Chile and Malaysia – have overcome many of the obstacles … and implemented sound pro-poor strategies”. There are similar references elsewhere to “success” stories – Botswana (Hope, 1998, Love, 1994), Chile (Schurman, 1996), Indonesia (Usui, 1996), Malaysia (Rasiah and Shari, 2001), and Norway (Wright and Czelutsa, 2002).
Nigeria is Africa’s most populous country with close to 132 million inhabitants. However, approximately 55% of the population lives on less than the value of one US dollar per day. The Nigerian economy depends heavily on the oil sector, which contributes 95% of export revenues, 76% of government revenues and about a third of gross domestic product. Before the establishment of democracy in 1999, the country was governed by military generals, under whose rule Nigeria’s economic performance had taken a beating for 15 consecutive years (Datamonitor, 2007).
Nigeria has a dual economy with a modern segment dependent on oil earnings, overlaid by a traditional agricultural and trading economy. At independence in 1960 agriculture accounted for well over half of GDP, and was the main source of export earnings and public revenue. The oil sector, which emerged in the 1960’s and was firmly established during the 1970’s, is now of overwhelming importance to the point of over-dependence.
Undoubtedly, Africa and indeed Nigeria is facing an economic crises situation featured by inadequate resources for long-term development, high poverty level, low capacity utilization, high level of unemployment and other Millennium Development Goals (MDGs) increasingly becoming difficult to achieve by 2020. Foreign direct investment has assumed prominent place in her strategy as a way of boosting economic rival and growth. It is also seen by policy makers at all levels as a way of bridging the resource gap of the country and avoiding further debt build-up (UNCTAD, 2005).
This has brought about several changes in policy and regulations in order to encourage foreign investor to invest in the country. Other measures include – the liberalization of the foreign investment regime to allow major foreign ownership, lifting foreign exchange controls and the privatization of Nigeria’s public enterprises. This research is aimed to take an in-depth analysis of the major private capital flow – foreign direct investment to a growing economy; Nigeria. This investment trend will be narrowed down to the extractive sector and in particular the oil and gas sector with the aim of investigating how investment in this sector translate to economic growth.
1.6 Research Gap
During the last decade, a number of interesting studies in the role of foreign direct investment in stimulating economic growth has appeared. Several authors have observed that the major reason for increased effort in attracting more FDI has been stemmed from the belief that FDI has several positive effects (Levine and Carkovic, 2002, Caves, 1996).
In contributing to the importance of FDI, it has also been shown that FDI is three times more efficient than domestic investment (De-Gregorio, 2003). Available evidence for developed countries seems to support the idea that productivity of domestic firms is positively related to the presence of foreign firms (Globerman, 1979). The result for developing countries are not clear, with some finding positive spillover (Blomstrom, 1986, Kokko, 1994), and others reporting limited evidence (Aitken et al., 1997).
Earlier studies on FDI showed that target countries receive very few benefits and in most cases negative effect on economic growth (Singer, 1950; Prebisch, 1968; Saltz, 1992; Bos et al., 1974 cited in (Katerina et al., 2004). A positive effect is only contingent on the ‘absorptive capacity’ of the host country (Durham, 2004). Many research have shown that FDI stimulates economic growth (Borensztein et al., 1998, Amy Jocelyn and Kamal, 1999) as seen in china’s economic growth (Dees, 1998 cited in (Ayanwale, 2007) and Latin American countries (Mello, 1997) showing that inflow of capital brings about increase in investment level.
FDI has also been shown to have both a positive and negative effect on economic development depending on the variables that are used along side the test equation (UNCTAD, 1998; 1999). Its effect has also been more positively acclaimed in countries with higher institutional capabilities (Olofsdotter, 1998) and economically less advanced countries (like Philippines and Thailand) but negatively on more economically advanced countries like Japan and Taiwan (Bende-Nabende and Ford, 1998). In essence, the impact FDI has on growth of any economy may be country an period specific and as such there is a need for country specific studies.
Several studies have shown varying relationship between FDI and economic growth in Nigeria. For example, Odozi (1995) study showed that Structural Adjustment Policies (SAP hereafter) of Nigeria contributed to the FDI-growth relationship. He revealed that macro-policies before SAP discouraged foreign investors. Ogiogo (1995) reported a negative contribution of public investment to GDP growth for the reason of distortion. However, positive linkage effect of FDI-growth relationship was shown by Aluko (1961). Private domestic investment was also shown by Ariyo (1998) to contribute positively to raising GDP-growth rate for the period 1970-1995.
Oyinlola (1995) using Chenery and Stout’s two-gap model found a positive relationship between FDI and economic growth. Ekpo (1995) using time series data revealed that political regime, real income per capita, inflation rate, credit rating and debt service were key factors explaining variability in FDI into Nigeria. Using unrelated regression model, FDI was shown to be pro-consumption and pro-import hence showing a negative relationship to domestic investment (Adelegan, 2000 cited in Ayanwale, 2007) and statistically insignificant effect was shown for FDI-growth (Akinlo, 2004).
More recent findings by Ayanwale (2007) revealed that FDI contributes positively to Nigeria’s economic growth with the communication sector accounting for the highest potential to grow that economy. He also opined that FDI in the manufacturing sector has a negative relationship with economic growth suggesting that the business climate is not healthy enough for the manufacturing sector to thrive and contribute to positive growth.
Crude oil discovery and exploration has been said to have both positive and negative effect on Nigeria. The negative side is seen in term of the environmental degradation, deprived means of livelihood and other economic and social factors experienced by surrounding communities where the oil wells are exploited while the positive side is viewed from the large proceeds from domestic sale and export of petroleum products. However, its effect on the growth of the Nigerian economy as regards returns and productivity is still questionable (Odularu, 2007).
This review shows that the debate on the impact of FDI on economic growth is far from being conclusive. The role of FDI can be country specific and its relationship with growth can either be positive, negative or insignificant depending on the macroeconomic dispensation (economic, institutional and technological conditions) in the recipient country (Zhang, 2001). Even though none of these studies controlled for the fact that must of the FDI was concentrated in the extractive industry, they did not specifically investigate the relationship between oil-FDI and economic growth. This is the focus of this study.
1.7 Research Objectives and Questions
Few research on FDI into Sub-Saharan Africa have shown empirical evidence of FDI and economic growth as ambiguous (Ayanwale, 2007). In theory FDI is believed to have several positive effects on the economy of host country (such as productivity gains, technology transfers, the introduction of new processes, managerial know-how and skills, employee training etc), promoting its growth and in general, a significant factor in modernizing the host country’s economy (Katerina et al., 2004). However, there is no clear understanding of its contribution to growth (Bora, 2002).
This research was driven by the following questions:
Has foreign direct investment into Nigerian oil and gas sector brought about economic development?
What is the transmission mechanism through which FDI brings about growth
1.9 Dissertation Outline
The rest of the paper is organized as follows:
This chapter is the literature review and shall be discussed in three subsection. The first two sections shall seek to review the theories and motivation for Foreign direct investment and the third section deals with the theoretical and analytic review of literature on FDI – Growth linkages. This shall seek to answer the question on the mechanism through which FDI result in economic growth.
This chapter discusses the case study – Nigeria and reviews the contribution performance and challenges of the oil and gas sector in Nigeria. Also, the impact of this sector on economic growth is discussed.
The methodology and theoretical framework for the analysis is the objective of this chapter. This section discusses the research approach and data collection mode. The variables for analysis and the model for shall be derived.
Data Analysis of the result and findings shall be the aim of this chapter.
This chapter shall form the conclusion of the research and give a summary of the findings, suggestion for improving economic growth in Nigeria and recommendation for further study.
Foreign direct investment is in general motivated by both “pull” and “push” factors. The push factors are external to developing countries and focuses majorly on growth and financial market conditions in industrial countries. On the other hand, the pull factors are dependent (on a lot of factors) domestic policies and characteristics of host countries. While the push factors determine the totality of available resources, the push factors determine its allocation between countries (Ajayi, 2004).
The diversity of theoretical and empirical explanations for the impact and influence of FDI (and growth) is without doubt very rich. Many studies among others have emphasized conducive macroeconomic policy, increased liberalization of markets, large domestic markets, liberal trade regime, low labour cost, availability of natural resources, good infrastructure and investment in human capital (bring about an educative workforce) (Ajayi, 2003).
This review therefore draws from many of these works with the particular aim of providing an understanding of the theoretical and empirical background, views and present thought on the relationship between FDI and economic growth.
The discussion shall be presented in three sections. The first two sections shall discuss the theories and motivation for FDI and the third section involves theoretical and empirical review of the literature of FDI and economic growth from four perspectives: trade or export (openness), linkages and spillover effect, knowledge and technology transfer and human capital.
3.1 Theories of FDI
FDI can take the form of a Greenfield investment in a new facility or an acquisition of or merger with an existing local firm. Majority of cross-border investment is in the form of merger and acquisition rather than Greenfield investments. According to estimates by United Nations, 40 to 80 percent of all FDI inflows between 1998 and 2005 were in the form of mergers and acquisition (Hill, 2009). However, FDI flows into developed nations are different from those of developing nations. For developing nations only about one- third of FDI is in the form of cross-border merger and acquisition. This may simply reflect the fact that there are fewer firms to acquire in developing nations (Hill, 2009).
For the purpose of this research, I have concentrated on two theories of FDI which are relevant to the study. The first perspective explains why firms in the same industry often undertake FDI at the same time and why certain locations are favoured over others (i.e. the observed pattern of FDI). The second is known as the eclectic paradigm. This perspective is eclectic because it combines the best aspects of other theories into a single explanation.
In proceeding with the discussion, we define some terms. When goods are produced at home and then shipped to the receiving country for sale, it is known as exporting. The process of granting a foreign entity (the licensee) rights to produce and sell the firm’s product in return for a royalty fee on every unit sold is known as Licensing.
Foreign direct investment has been view as an expensive and risky venture compared to exporting and licensing. This is because firms bear the cost of establishing production facilities in a foreign country or acquiring a foreign enterprise and the risk of doing business in countries with different culture. In exporting, firms need not bear cost associated with FDI and risk can be reduced by the use of local sales agents. Similarly, under licensing, the licensee bears the cost and risks. However, it is worth noting in summary that firms will choose FDI over exporting as an entry strategy when transportation costs or trade barriers make exporting unattractive. Furthermore, firms will favor FDI over licensing (or franchising) when it wishes to maintain control of technological know-how or over its operations and business strategy or when firm’s capabilities are simply not amenable to licensing (Hill, 2009).
3.1.1 The Pattern of FDI
220.127.116.11 Strategic Behaviour
The idea that FDI flow reflects strategic rivalry between firms in the global marketplace is the basis for one of the theories of FDI. In studying the relationship between FDI and rivalry in oligopolistic industries F. T. Knickerbocker proposed a variation to this argument. An oligopoly is an industry made up of a small number of large players (for example, an industry in which four firms control 80 percent of a domestic market). One key features of such market is the interdependence of major players: the action of one firm have immediate impact on the major competitors, forcing a response in kind.
This interdependence leads to imitative behaviour; rivals are usually quick to imitate opponents in and oligopoly – “the bandwagon effect”. Imitative behaviour can take many forms in an oligopoly. Some good examples are price war and capacity increase. Rivals imitate lest they be left at a disadvantage in the future. F. T. Knickerbocker argued that the same kind of imitative behaviour characterizes FDI.
Although Knickerbockers’ theory and its extensions can help to explain imitative FDI behaviour by firms in oligopolistic industry, it does not explain the choice and efficiency of FDI over exporting or licensing. This is explained by the internalization theory.
18.104.22.168 The Product Life Cycle Theory
The product life cycle theory was proposed by Raymond Vernon in the mid-1960s and was based on the observation that for most of the 20th century, a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market (e.g. automobiles, photocopiers, televisions and semiconductor chips). Vernon opined that the wealth and size of the U.S. market gave U.S. firms a strong incentive to develop new consumer products and the high labour cost also gave firms in the U.S. an incentive to develop cost-saving process innovations.
The theory went further to argue that early in the life cycle of a typical new product, while demand is starting to grow rapidly in the United States, demand in other advanced countries does not make it worth while for firms in those countries to start producing the new product, but it does necessitate some export from the United State to those countries. However, over time the demand for new product starts to grow in other advanced countries. As this happens, foreign producer begin to produce at home for their own market and growing demand causes U.S. firms to setup production facilities in those advanced countries. This limits the potential for export for the United States. Finally, at maturity product becomes standardized, cost consideration start to play a greater role in the competitive process and producer in advanced countries with lower labour cost than the U.S. might now begin to export to the United States. Under intense cost pressure, the cycle by which the United State lost its advantage to other advanced countries might be repeated once more as developing countries begin to acquire a production advantage over advanced countries (Hill, 2009).
The effect of these trends is that over time the United States switches form being an exporter of the product to an importer of the product as production becomes concentrated in lower-cost foreign locations.
The product life cycle seems to be an accurate explanation of international trade patterns. Howeve