Foreign direct investment and export diversification in developing countries

Abstract

This study examines the individual and interactive impact of foreign direct investment (FDI), domestic production structure, infrastructure, natural resource endowment, and fiscal incentives on export diversification. The econometric estimation is based on a dynamic systems general method of moments (sGMM) analysis using panel data from 44 Sub-Sahara African (SSA) countries. The study finds a positive export-diversifying effect of FDI in SSA suggesting that FDI has an influence on the composition of export baskets in host economies. Furthermore, diversifying production sectors, credible institutions, and macroeconomic stability are essential for promoting export diversification, while landlockedness and natural resource endowments contribute to export concentration. The study finds that the FDI’s impact on export diversification is reinforced by better access to infrastructure and fiscal incentives to foreign investors in special economic zones (SEZs). The latter results compare with findings by Farole and Moberg (2017), while the importance of infrastructure in export diversification is emphasised by Fosu (2021). The findings from this study are particularly important to SSA economies that other than having highly concentrated export baskets have in recent years faced declines in FDI albeit limited domestic capital and government resources needed to propel export diversification. SSA economies must focus on efforts to attract more FDI possibly through regulatory reforms that grant foreign investors fiscal incentives for investing in targeted sectors and operating in SEZs.