Foreign Direct Investment & Exports: the Case of Ghana

 This article is thesis writing /review on the topic, "Foreign Direct Investment: Evidence from Ghana."

Researcher: K. A. A.

1.      Introduction

In today’s global economy, stronger international economic partnerships are increasingly important to ensure the health and vitality of regional economies. Whether through international exports or foreign direct investment (FDI), these international links enable businesses and other actors in regional industry clusters, to develop new ideas, identify new markets for goods and services, and take advantage of new resources to grow and expand their regional economies. As such, the development of international trade is an important part of the innovation ecosystem necessary to foster strong economic growth.

The debate over the merits of globalisation cannot be settled until a firm understanding of how globalisation affects human welfare is gained. Since long-run human welfare depends on economic growth, we must get a better handle on globalization’s effects on economic growth. Globalisation covers a wide array of economic activities, including international trade, international migration, and international investment. An accurate assessment of whether globalisation is good for economic growth requires the examination of the growth effects of all of the components of globalization (Roy & Berg, 2006).

Foreign direct investment is an indication of growing transnational ownership of production assets. It is a leading edge of economic globalisation in the sense that increasing foreign ownership of production may give direct influence over livelihoods and production. The implications of foreign ownership of production may include both positive and negative elements, depending on the perspective of the observer. Foreign investment has often been an important avenue for the transfer of skills and technology. At the same time, foreign investment puts workers under foreign control, and leads to foreign appropriation of profits.

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Foreign direct investment facilitates an international division of labour to take advantage of international trade opportunities by increasing the mobility of factors of production. This takes place through the process of globalisation. Globalisation has opened up countries’ economies which had hitherto been secluded to allow for the transfer of technology, human capital and technical know-how, as well as knowledge. This has benefited a lot of countries not only the so called developing but also the already developed. The United States which is by far a developed country in terms of size of its economy and also technology continues to receive a substantial amount of FDI (Roy & Berg, 2006); and so do most developed countries.

Foreign direct investment is dramatically increasing in this age of globalization. It has played important role for economic growth in this global process. But, the distribution of FDI is uneven in all over the world. Some countries are ahead and some lag behind in attracting foreign direct investment. The poorest countries are disappointing in attracting FDI (Khan, 2008). In recent times, developing countries, especially in Africa see the role of foreign direct investment as crucial to their development.

FDI is seen as an engine of growth as it provides the much needed capital for investment, increases competition in the host country industries, and aids local firms to become more productive by adopting more efficient technology or by investing in human and/or physical capital. Foreign direct investment contributes to growth in a substantial manner because it is more stable than other forms of capital flows. The benefits of FDI include serving as a source of capital, employment generation, facilitating access to foreign markets, and generating both technological and efficiency spillover to local firms. It is expected that by providing access to foreign markets, transferring technology and generally building capacity in the host country firms, FDI will inevitably improve the integration of the host country into the global economy and foster growth.

Asiedu (2003) argues that despite the facts that developing countries have reformed their institutions, improved their infrastructure and liberalized their FDI framework to attract foreign investment, the degree of reform was mediocre especially in SSA and this has led to the region attracting less amount of FDI. OSAA and NEPAD-OECD (2010) asserts that for FDI to contribute fully to economic and social progress in Africa, host-country governments need to create a policy environment that enables them to maximize development returns on investment. Governments should thus develop a set of policies that are not only focused on investment promotion, but also address issues such as human capital, infrastructure and enterprise development, and are likely to increase FDI spillover effects and contribute to economic diversification. This is all the more important because FDI in Africa, with a share of about 5 percent of global flows, remains small compared to flows to and among industrialised and major emerging countries.

Overall, the evidence suggests that FDI can be growth-enhancing for LDCs. However, an export orientation, economic development threshold level, a human capital endowment threshold level, and complementarities between FDI and domestic investment might all be necessary conditions for the relationship to hold. Evidence also seems to suggest that FDI is more growth enhancing than domestic investment (Borensztein, de Gregerrio, & Lee, 1995). These conditions are necessary for the attraction of FDI to LDCs. It must be stressed, however, that FDI to LDCs has slacked in the last couple of years with Africa receiving much less.

The last two decades has seen improvements in FDI to Africa albeit marginal compared to that of the rest of the world. This has become an important source of economic development for the continent. With an increase from approximately US$ 9 billion in 2000 to US$ 18 billion in 2004 and US$ 88 billion in 2008, FDI has become a major source of finance for Africa’s development. This is, however, mediocre as Africa account for only 5% of global flows of FDI (OSAA & NEPAD-OECD, 2010).

After a record high in 2008, the continent saw its FDI inflows falling by 36% in 2009. This marked the end of six consecutive years of increases in FDI flows to Africa. To take only a single example, FDI flows from OECD countries to Africa reached a record level of US$ 32 billion in 2008, compared to about US$ 4 billion in 2002. Figure 1 shows the pattern of FDI inflows to Africa. As for the regional distribution of FDI in Africa, the North, West and South of the continent attract the bulk of foreign investment. Much of this investment is driven by these regions’ large reservoirs of natural resources such as gas and petroleum. The Southern part of the continent received the most share of FDI (US$27 billion) the bulk of which went to South Africa and Angola.

Foreign Direct Investment (FDI) and exports relationship has received a lot of attention from researchers and justifiably so. Direction of this relationship has also led economists to draw diverse conclusions on the subject matter.

According to OECD (2008), foreign direct investment reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor. 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 on the management of the enterprise. The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is evidence of such a relationship (OECD, 2008).

Some compilers may argue that in some cases, an ownership of as little as 10% of the voting power may not lead to the exercise of any significant influence while on the other hand, an investor may own less than 10% but have an effective voice in the management. Nevertheless, the recommended methodology does not allow any qualification of the 10% threshold and recommends its strict application to ensure statistical consistency across countries (OECD, 2008). 

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FDI is thought to be growth-enhancing mainly through the capital, technology and know-how that it brings into the recipient country. By transferring knowledge, FDI will increase the existing stock of knowledge in the host country through labor training, transfer of skills, and the transfer of new managerial and organizational practice. FDI will also promote the use of more advance technologies by domestic firms through capital accumulation in the domestic country. Finally, FDI is thought to open up export markets and to promote domestic investments through the technological spillovers and the resulting productivity increase. Overall FDI is thought to be more productive than domestic investments. Indeed, as Graham and Krugman (1991) argue, domestic firms have better knowledge and access to markets, so for a MNC to enter it must have some advantages over the domestic firms. Therefore, it is likely that the MNC will have lower costs and be more productive thanks to technology and know-how.

Ghana like any other SSA country has benefited immensely from FDI inflows. FDI has served to open up the economy to more investors as FDI attract tax incentives and restrictions on foreign investments have also been eased; it has also aided in the transfer of technology and knowledge. However, FDI to Ghana has served as a significant source of finance to many sectors of the economy albeit skewed towards the mining sector. Ghana, has since independence in 1957, adopted and implemented different investment policies by the various political regimes, both civilian and military. The aim is to create an enabling environment for local and foreign investors to operate so as to reap the benefits associated with especially the latter which include the transfer of capital, advanced technology and organizational forms; assisting human capital formation; and helping to create a more competitive business environment.

Though Ghana attracts most of its FDI in the natural resource (mining) sector, it is incomparable to that of South Africa and Angola. The mining law and the privatization programme in the late 1980s and mid-1990s though accounted for the flow of FDI to other sectors of the economy; it went mainly into the mining and services sector (banking and telecommunication). In the 2000s, FDI inflows have been growing positively, but still the country lags behind its close neighbours such as Nigeria and Cote d’Ivoire. This cause for concern considering Ghana's immense potential (Abosi, 2008).

Attracting FDI is preoccupation of Ghana’s opening up policies and economic Reforms. The successive governments in Ghana has developed various new legislations to improve investment conditions and the business environment in order to attract FDI and has been a top ten reformer globally for the second year in a row, according to the World Bank's Doing Business team. Ghana’s shares of FDI quadrupled from 2005 to $636M in 2006 and represent 19.4% of gross fixed capital formation according to 2008 World Investment Report (WIR). Ghana currently ranks 76th in inward FDI performance index. Foreign Direct investment plays an important role in the project finance plan in Ghana (Anokye & Tweneboah, 2009).

FDI inflows to the country have increased slowly over the years and 2011 was no exception as at the end of the third quarter, the target of US$1.5 billion set for FDI inflows into the country for the year 2011 had been exceeded (GIPC, 2011). This served as a source of finance for most projects in the country and encouraged the growth of the economy.

Traditionally, Ghanaian exports include cocoa, timber, and gold; others include tuna, aluminum, manganese ore, diamonds and horticulture. The mining sector has experienced substantial growth in recent years as new mining technology has permitted the profitable exploitation of lower grade ores. However agriculture still dominates the economy. Gold, timber and cocoa production are major sources of foreign exchange and revenue from their exports is immense. Europe has been a long standing and leading destination of Ghanaian exports over the years, followed by the United States.

Ghana’s exports has accounted for approximately 40% of GDP in recent years. Although a great deal of policy has been proposed and advanced, very little diversification has taken place since independence. Exports by commodity have not varied significantly since the 1970s and moreover, cocoa, gold, and timber combined still account for the largest share (70%) of total commodity exports. As a result, Ghana’s economy remains vulnerable to commodity price shocks (World Bank, 2007). World Bank (2007) find that, between 1998 and 2000, when cocoa prices dropped by almost 50%, although remaining positive, real GDP growth decelerated by 20%.

Ndulu, O’Connell, Bates, Collier, and Soludo (2008) note one peculiar characteristic of African growth is its persistent volatility, mainly as a result of lack of structural diversification and dependence on a narrow range of primary commodities implying during periods of global commodity price shocks, many countries are vulnerable. Commodity price variability is the primary cause of instability in Ghana export earnings, a major disincentive to investment (Ackah, Aryeetey, and Aryeetey, 2009).

Ghana has in the past 25 years pursued an aggressive export-led industrialisation. The reform of the country’s investment codes in the 1980s and the establishment of Export Processing Zones (EPZs) were part of efforts by government to raise the level of export earnings. The sweeping and unbridled trade liberalisation which took hold in the 1990s and got intensified thereafter further demonstrate the commitment of government to the export-led industrialisation dogma. Ghana’s economy has therefore become significantly integrated into the global economy as far as trade is concerned. The Government of Ghana (GoG) has identified increase of non-traditional exports as central to Ghana’s strategy to becoming a middle-income country by year 2020. This requires a doubling of its economic growth rate, sustained over several years.

While traditional exports of cocoa and gold remain an important source of economic growth and foreign exchange, diversification of exports is necessary to accelerate economic growth and reduce poverty and to minimize the country’s vulnerability to external price shocks.

Ghana’s traditional major export commodities are gold, cocoa and timber. Gold and cocoa contribute more than 80% of foreign exchange. Cash crops, comprising primarily cocoa, timber and others (coconuts, other palm products, shea-nuts and coffee) provide about two-thirds of export revenues, estimated at US$3.01 billion in 2004. The major export partners of Ghana are: Netherlands (11%), United Kingdom (10.6%), France (7.6%), Germany (6.2%), Japan (5.2%), Italy (4.6%), Nigeria (4.4%) and the United States of America (4.2%). The combination of unstable cocoa production, due to unfavourable weather conditions and the recent declines in world prices for cocoa and gold has reduced export earnings (Kasalu-Coffin, Bedingar, Dosso, & Diop, 2005).

With the decline in cocoa and gold world prices, the Government realised the need for diversifying its sources of foreign earnings into the production and export of horticultural products, which in turn will improve the livelihood of rural populations. By means of incentives, the government has engaged in promoting non-traditional exports (NTE) in the agriculture and fishing sectors since 1983. The NTE comprise all merchandise exports except for cocoa beans, logs and lumber and mining products. In 2004, the overall NTE accounted for 8.8% of GDP.

Between the period 2006-2007 and the first half of 2008, the top two importers of Ghanaian products were the Netherlands which imported 14 percent of the total exports of Ghana and the United Kingdom which imported 9.2 percent of Ghanaian exports. Cocoa, gold and timber constituted over 75 percent of Ghana’s commodity exports in 2008. In 2010, the major export partners of Ghana were the EU27 with a total volume of Ghanaian products of €1,3175million representing 38.7 percent of total exports from Ghana, followed by the United States of America with a total of €194,0million (5.7 percent) 2008 (DOTS, 2008). 

2. Statement of the Problem

FDI is an important source of financing for most investment projects in developing countries of which Ghana is no exception. Ghana has relied on FDI in major sectors of the economy with the mining sector leading the pack. Savings rate and therefore investment is very low locally and thus FDI is a very important source of alternative financing for most projects. Besides the provision of finance, FDI serves to transfer technology and technical know-how which are often in limited supply in Ghana. Especially for the least developed countries, FDI means higher exports, access to international markets and international currencies, being an important source of financing, substituting bank loans. With the transfer of technology from MNCs to local firms, capacity of local firms to produce is increased and this leads to enhanced production of output. Increased output allows local firms to export to foreign markets.

Exports have contributed immensely to the development of the Ghanaian economy by providing foreign reserves to finance government activity and also helped in opening up of the Ghanaian economy to foreign markets via trade. In recent years exports have accounted for over 40 percent of GDP. Ghana being an exported oriented economy has pursued vigorous export promotion strategies in order to increase the proceeds from exports. This has included policies that attract foreign direct investment to the country. Export oriented and efficiency FDI seek to make use of abundant resource to produce for exporting. Ghana has an abundance of natural resource in the form of raw materials and labor and this act as attraction of foreign investment. Tsikata, Asante and Gyasi (2000), for instance, found that the factors important for attracting FDI include export orientation factors such as trade regime, democratic governance, investment climate, economic uncertainty and raw material availability.

3.      Objective

The main objective of the study is to examine the relationship between FDI and Exports in Ghana.

4.      Key Findings

The empirical evidence from the study revealed that FDI inflows, foreign income, real effective exchange rate, and output level exerted a positive and significant effect on exports in the long run and short run.

This gives an indication that foreign investment is significant for improving export growth in the short and long term. Also, increase in foreign income, exchange rate appreciation, higher output levels leads to export growth in the short and long term.

The study revealed a negative but influence of inflation on exports in the short run and the long run. This gives an indication that lower rates of inflation serves to boost export expansion whereas higher rates adversely affect export performance by creating distortions in the production process and investment in both the short and long term.

Finally, the study revealed a bidirectional causality relationship between FDI and exports. This gives an indication that past values of FDI can help in explaining exports than using past values of exports only. Also, it implies that past values of exports can help in explaining past values of FDI than using FDI only. 

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5.      Recommendation

A stable macroeconomic environment serves to promote sound economic activity and as such invariably promote export growth. The Government of Ghana should target inflation to maintain lower inflation rates to ensure a stable macroeconomic environment to remove any distortion in the production process as well increase the rate on returns to investment. Thus maintaining inflation stability could ensure economic stability and in turn, stimulate export growth. Inflation should be maintained at lower rates relative to that of trading partners to ensure maximum benefit from depreciation of the cedi.

6.      Summary

usingThe study investigated the relationship between foreign direct investment and exports in Ghana quarterly data for the period 1986 to 2010. The Autoregressive Distributed Lag approach to cointegration was used to study this relationship. Exports were measured in terms of exports values as ratio of GDP, foreign direct investment was measured by FDI inflows as a ratio to GDP. The study employed as a measure of foreign income, the real GDP of the United States of America, real effective exchange rate was used as measure of competitiveness of Ghana’s exports, Ghana’s GDP was used as a measure of output level, and inflation was used as measure of macroeconomic stability.

Results from the study suggest that FDI is important for export growth in Ghana and thus complements exports. Granger causality test revealed a bidirectional causal relationship between FDI and exports. The results also revealed that foreign income, exchange rate and output level positively impact exports. Lower rate of inflation was found to be conducive for export expansion.

Thus, the study recommends that policy should focus on maintaining an open and export oriented policy in order to attract the needed FDI to the export sector. Also, a stable macroeconomic environment via low rates of inflation should be maintained by the government to remove distortions in the production process to further enhance export growth.

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Some References

Abosi, E.N. (2008). Determinants of foreign direct investment in Ghana (1975-2005). United Nations African Institute for Economic Development and Planning, New York, United States. Unpublished Master’s Thesis.

Ackah, C. G., Aryeetey E., & Aryeetey, E. (2009). Global financial crisis. (Discussion Series Paper 5). Overseas Development Institute, London. Retrieved www.odi.org.uk/resources/docs/43 25.pdf.

Agarwal, J. (1980). Determinants of foreign direct investment: A survey. Weltwirtschaftliches Archiv, 116(4), 739-773.

Ahmed, A.D., Cheng, E. & Messinis, G. (2008). The role of exports, foreign direct investment, and imports in development: New evidence from Sub-Saharan African countries. CSES Working Paper, No. 39. Melbourne, Australia: Victoria University. Retrieved from http://www.cfses. com/documents/wp39.pdf

Aizenman, J., & Noy, I. (2006). FDI and trade: Two-way linkages? The Quarterly Review of Economics and Finance, 46(3), 317-337.

Ajayi, S. I. (2006). Foreign direct investment in Sub-Saharan Africa: Origins, targets, impacts, and potential. Nairobi: AERC.