FDI and inequality in Sub-Saharan Africa: does democracy matter?

Abstract

Purpose: This paper investigates whether democracy plays a mediating role in the relationship between foreign direct investment (FDI) and inequality in Sub-Saharan Africa (SSA). Design/methodology/approach: The empirical analysis is conducted using fixed effects and system GMM (Generalised Method of Moments) on a panel of 38 Sub-Saharan African countries covering the period of 1990–2018. Findings: The results find that FDI has no direct effect on inequality whereas democracy reduces inequality directly in both the short run and the long run. The sensitivity analyses find that democracy improves equality regardless of the magnitude of FDI, resource endowment or democratic deepening whereas FDI only reduces inequality once a moderate level of democracy has been achieved. Social implications: The results discussed above thus have four policy implications. First, these results show that although democracy has inequality reducing benefits, SSA is unlikely to significantly reduce inequality unless the region purposefully diversifies its trade and FDI away from natural resources. Second, the region should continue to expand credit access to reduce inequality and attract FDI. Third, policymakers should undertake reforms that will reduce youth inequality. Lastly, the region should focus on long-run democratic reforms rather than on short-run democratization to improve governance and investor confidence. Originality/value: Although there are existing studies that examine the association between FDI and inequality, FDI and democracy and democracy and inequality, this is the first study to explicitly examine the effect of democracy on the association between FDI and inequality in SSA, and the first study to separately consider the possible varied effects of contemporaneous democratization versus the long-run accumulation of democratic capital. In addition, rather than measure inequality by income alone, this study uses the more appropriate Human Development Index to account for SSA's sociological, education and income disparities.