Foreign direct investment and welfare nexus in sub Saharan Africa

Abstract

Governments of developing countries have been targeting poverty alleviation and deprivation as their main goal and thus have been working for pro poor growth. It is observed that African countries need considerable amount of investment in order to help their economies to prosper. African countries can benefit from growth through foreign investment which is seen as an important source of capital flows. However, even if growth is important for an economy, it is not a good indicator of social development. Welfare can be worsen if growth attained by a country is not pro poor and can also result in an increase in inequality gap. In this regards, this study is based on the investigation on FDI and poverty alleviation or welfare maximization in selected Sub Saharan African countries. The present paper takes a different approach in analyzing the impact of FDI on poverty reduction. In the context of selected Sub Saharan African countries and over the period 1990-2010, a dynamic Panel vector error correction model is adopted. In effect the Vector autoregressive model or the vector error correction model is of great importance in showing the dynamic behavior of economic time series and for forecasting. Also, it often provides better forecasts and describes theory-based simultaneous equations models. Thus, given the endogeneity and causality issues, using such a model can prove to be highly beneficial. The main variables used are FDI net inflows and poverty headcount index. Other variables used in this study include the unemployment rate, inflation, openness, government debt and government expenditure, education level and GDP per capita. The results suggest that indeed FDI is an efficient tool in fighting poverty both in the short run and long run with the sample of countries considered. Moreover, the results favor a uni directional relationship between FDI and social welfare (poverty reduction) and a bi directional causality between FDI and economic welfare (Economic growth). According to this study, foreign investment is an important ingredient for both economic and social development for Sub Saharan African countries. Hence, the government should devise appropriate policies to attract such capital flows. These can be in terms of an improvement in institutional capacity and easier administrative procedures which would surely favor the entrance of foreign firms in the host countries.

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