The Effect of Foreign Direct Investment on Economic Growth in Sub-Saharan Africa: A Panel Vector Autoregressive Approach

Abstract

This study estimates the effect of FDI on GDP growth using a panel vector autoregression model and a vector error correction model— econometric models that have yet to be applied to this question for sub-Saharan Africa. Using annual data from 1990-2017 for a sample of twenty sub-Saharan countries, I find that FDI has no effect on GDP growth for the full sample. However, when the sample is restricted to seven countries that had only positive FDI inflows in the time period considered and were in the top 50th percentile of receivers, FDI has a positive short run effect on GDP growth. The VECM estimation suggests heterogeneous effects in different sub-Saharan African countries, with countries that were the top receivers of greenfield manufacturing FDI showing greater positive response of GDP growth to FDI. My estimations suggest that these countries need to work on (1) attracting more FDI, and I lend evidence to support the idea that increasing their composite risk rating can achieve this; (2) attracting the type of FDI that establishes linkages in the domestic economy for spillovers to occur; and (3) building up their human capital to the minimum threshold for spillovers to occur.

Keywords: Foreign direct investment (FDI); GDP growth; sub-Saharan Africa; panel vector autoregression (panel VAR); vector error correction model (VECM)