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This paper re-examines the relationship between foreign direct investment (FDI) inflows and welfare (or poverty reduction) in Africa. Using FDI net inflows per capita and the United Nations Development Program’s Human Development Index as the principal variables, our analyses confirm the positive and strongly significant relationship between FDI net inflows and poverty reduction in Africa but find significant differences among African regions. We also find that FDI has a greater impact on welfare in poorer countries than it does in wealthier countries. For instance, while the relationship between FDI and poverty reduction is positive and significant for economic communities in Central and East Africa, it is non-significant in Northern and Southern Africa. Furthermore, the relationship was found to be ambiguous in West Africa. Our results are robust to many model specifications.

The United Nations’ Millennium Declaration of 2000 outlines eight Millennium Development Goals (MDGs) for 2015.1 All eight aim to accelerate human development and reduce poverty in developing nations. Unfortunately, at present, most African countries are off-track with respect to meeting these goals. To redress the situation, significant amounts of capital investments are required. An important source of capital investments is foreign direct investment (FDI). In most African countries, the private sector is recognized as a principal driver of growth. Hence, FDI is critical to achieving the MDGs. As the financial and economic crises have persisted, however, most developed countries have begun to design economic and fiscal policies to keep capital at home, thus putting the MDGs in even greater jeopardy.2 Because of their development levels, African countries need continuous foreign investments to stimulate their economies and trigger reductions in poverty. Over recent decades, FDI to Africa has increased both in terms of average net inflows of FDI per capita and as a proportion of the gross domestic product (GDP) (United Nations Conference on Trade, 2010b). At the same time, real per capita GDP as well as the Human Development Index (HDI)3 has been improving (United Nations Development Programme (UNDP), 2010). More FDI, thus, appears to be linked to better welfare4 or less poverty. The literature is rich in studies analyzing the causal relationship between FDI and economic growth (e.g., Chowdhury and Mavrotas, 2006, Alfaro, 2003, Alfaro et al., 2004, Alfaro et al., 2010, Apergis et al., 2008, Carkovic and Levine, 2005 and Hansen and Rand, 2006). These studies analyze the overall impact of FDI on economic growth, assuming a perfect positive correlation between economic growth and welfare. However, this assumption has been questioned (e.g., Anand & Sen, 2000). Indeed, economic growth with inequality may maintain or increase the level of poverty in a country. More specifically, even if economic growth has been found to be necessary in improving well-being, economic growth that is not pro-poor (i.e., not redistributive) may create inequality and may actually negatively impact welfare (Ravallion, 2007). At the same time, the literature has been limited due to the difficulty in measuring welfare and economic development. Two popular indicators in this area are GDP per capita and poverty incidence.5 The former is widely used and is available for all countries on an annual basis though it only measures one dimension of development. The latter is a good measure of overall well-being, but the data are not available for all countries. Even where the data are available, not all countries use the same measurement indicators. Over the last three decades, the United Nations Development Program’s (UNDP) HDI has become (almost) the universally accepted measure of human development. At present, HDI is readily available for all countries. Nonetheless, the few researchers who have used HDI to analyze FDI’s direct impact on welfare have focused on Asia or on low- and middle-income countries (Sharma & Gani, 2004). To our knowledge, no study using HDI has been carried out for African countries. Finally, several studies have shown economic integration to be important in attracting FDI. Asiedu (2006), for example, finds that the size of a country’s market as measured by GDP is a key determinant of FDI inflows. The majority of African countries have relatively small markets. To overcome this limitation, most multilateral and bilateral development agencies promote regional integration as a means of attracting FDI and, thereby, improving growth and reducing poverty (UNCTAD, 2010a and UNECA, 2010). This paper studies the relationship between FDI net inflows and poverty reduction in Africa, especially in Africa’s regional economic communities (RECs). We explore two research questions: (1) does FDI reduce poverty in Africa? and (2) does FDI reduce poverty more in some African regions than in others? We consider five RECs: the Arab Maghreb Union (AMU), the Economic Community of Central African States (ECCAS), the Economic Community of West African States (ECOWAS), the Intergovernmental Authority for Development (IGAD), and the Southern African Development Community (SADC). We also consider five customs and monetary unions: the Economic and Monetary Community of Central Africa (CEMAC), the East African Community (EAC), the Southern African Customs Union (SACU), the West African Economic and Monetary Union (WAEMU), and the embryonic West African Monetary Zone (WAMZ). Insofar as capturing levels of human development is concerned, we use HDI as our key welfare or poverty-reduction indicator. As a check and to ensure robustness, we also use an alternate welfare measure common to the literature, real GDP per capita. To measure FDI, we use net per capita inflows of FDI. Our alternative measure is the ratio of total FDI net inflows over GDP and the ratio of total FDI net inflows over gross capital formation (GCF). This paper’s contribution to the literature is twofold. First, we believe this study to be the first to analyze the extent to which FDI reduces poverty in Africa. Second, our study analyzes how membership in an REC impacts the ability of FDI to reduce poverty. Using the Granger causality Wald test, our analyses find a positive causal relationship between FDI and welfare in Africa. Moreover, our panel and cross-sectional regression analyses indicate that FDI impacts welfare positively and significantly in Africa and that the relationship is robust to different model specifications. However, FDI’s impact on welfare differs between African regions. For instance, in Central and East African RECs (CEMAC, EAC, ECCAS, and IGAD), FDI impacts welfare positively and significantly, whereas in Southern and Northern African RECs (AMU, SACU, and SADC), the impact of FDI on welfare is not significant and in West Africa (ECOWAS), it is ambiguous; that is, its impact is negative and non-significant in the WAEMU region and is positive and non-significant in the WAMZ region. This paper is organized as follows. Section 2 reviews the literature on the relationship between FDI and economic growth and between FDI and welfare. Section 3 discusses our methodology and describes our variables and our sample of countries and regions. Section 4 presents the empirical results of our analysis of the relationship between FDI and welfare in Africa and Africa’s RECs. Section 5 concludes and formulates policy recommendations.

This paper assesses the impact of FDI on welfare across African regions using the HDI and the real per capita GDP as welfare measures. To measure FDI, we used per capita FDI net inflows, FDI net inflows over GDP, and FDI net inflows over gross capital formation (GCF). As was done in other studies, we controlled for the phenomena that affect welfare and economic growth: economic and policy factors, the business environment and the quality of institutions, and political risks. On this basis, we find a strongly positive relationship between FDI and welfare improvement at the level of Africa as a whole. This relationship holds even after we control for government size, country indebtedness, macroeconomic instability, infrastructure development, institutional quality, political risk, openness to trade, education, and financial market development. When we analyze the data for various African regions, however, we find that FDI’s impact on welfare differs. Our results suggest that the poorer and less developed the host country, the greater the impact of FDI on poverty reduction. However, in absolute terms, richer countries may benefit more than poorer countries. Two main policy recommendations can be drawn from our findings. First, in terms of reducing welfare differences between countries in the same region, regional policies to attract FDI should be carefully designed to direct those investments toward the most productive sectors of the economy, particularly for the less developed countries. Indeed, these investments will create jobs, develop local skills, and stimulate technological progress, thus reducing poverty and improving welfare in the whole region. Second, in terms of reducing inequalities within a country, enough incentives should be provided to encourage foreign investments into labor-intensive and pro-poor sectors, such as agriculture, education, health, and infrastructure development. Of course, the political, social and economic context of host countries will influence the choices to be made in terms of incentive policies and sectors to be prioritized. Several methods exist to identify these priority sectors. One of them is the growth diagnostic framework that international development agencies have recently begun to implement. For this paper, unfortunately, due to data limitations, we do not use disaggregate data with enough detailed information on sectorial FDI and incentive policies to attract FDI. We leave these interesting and important issues for future research.