What Drives Foreign Direct Investment into Africa? Insights from a New Analytical Classification of Countries as Fragile, Factor-Driven, or Investment-Driven

Abstract

This paper revisits the key factors that drive foreign direct investment (FDI) flows into Africa. The approach departs from previous cross-country studies, which pool all countries together in one sample without due consideration for structural or behavioral differences between them. Instead, it involves a novel analytical classification of African economies based on economic and institutional fundamentals that account for the heterogeneity between countries. This involves classifying countries as fragile, factor-driven, or investment-driven. The main objective of this paper is to examine and uncover any nuances or variations in the factors that attract FDI into different categories of African economies. Using a panel cointegration approach for the period 1996–2018, the empirical analysis reveals that the factors influencing the flow of FDI vary significantly across the different analytical country classifications developed. The study finds that natural resource abundance is a crucial factor in the short term for all countries. However, in the long term, it is only important for fragile and factor-driven economies, not for investment-driven economies. While government effectiveness is an important factor for all countries, political stability is important only for investment- and factor-driven countries. Contrary to conventional wisdom, openness is only important for investment-driven countries. Similarly, macroeconomic stability and domestic investment are also found to be important only for investment-driven economies. The findings suggest the need to emphasize different policies in various countries or groups of countries.