Sizwe Mbele: Beware the Foreign Direct Investment trap

The campaign for Investment inflows by President Cyril Ramaphosa is unlikely to yield desired outcomes if local conditions are not ready – and conducive.

South Africa has always been characterised by persistent and stark inequalities. A small percentage of regions in the country contribute to the bulk of the country’s output in largely capital-intensive sectors with low multiplier effects. Despite some progress made to address these challenges, the situation has remained largely unchanged since 1996. Over the past two decades, the official rate of unemployment has increased from 17% in 1994 to around 26% in the first quarter of 2018. Gross Domestic Product (GDP) is growing at about 1.5%, which is less than the desired 5% annual growth.

In his quest to enhance economic growth and job creation, in April (this year) President Cyril Ramaphosa announced an ambitious drive to attract $100-billion in investment over five years and appointed four prominent envoys to campaign for both domestic and foreign investment. Since then, the investment campaign has been the centrepiece of Ramaphosa’s policy avowals.

Emphasising increased FDI inflows as a key pillar of a new strategy to recalibrate the economy, in June he hailed Mercedes-Benz’s announcement of a R10-billion investment in the expansion of its East London plant. During visits to Saudi Arabia and the United Arab Emirates, he won investment pledges of $10-billion from each. In July, during a state visit by Chinese President Xi Jinping, Ramaphosa secured another pledge of $14.7-billion in increased investment, and as co-chair of the Forum for China-Africa Co-operation (Focac) in September welcomed a further $60-billion in new development funding by China for the African continent over the next three years.

In his address to 48 African Heads of State at the Focac Summit in Beijing, President Xi also announced that the previous pledge of US$ 60 billion at the Focac Summit has either been delivered or rearranged. Least developed countries in the continent with diplomatic relations with China would be exempted from outstanding intergovernmental interest-free loan debts from the end of 2018; this is part of non-concessional. (Let’s put the controversy aside – of China’s burgeoning economic presence in Africa and purportedly, “debt-trap diplomacy”; a subject for another discussion.)

Given the theoretical relationship between FDI and economic growth in recipient countries, the campaign for foreign investment is therefore a positive step. However, despite a clear recognition by President Ramaphosa of the need to create conducive environment to attract investment and unlock the growth potential of the South African economy, the real-world effect is not fully known.

The prior question is whether the attraction of more FDI inflows is sufficient for inclusive growth. Will more FDI mean more jobs, and if so, will these be sustainable? What industries are being targeted? How is business meant to respond? Referencing, Korea, Japan and (to a lesser extent) Taiwan. Prof Rajneesh Narula reminds me (us) that there is no evidence that FDI causes (inclusive) economic development. There is a positive correlation between FDI and economic growth. One can concede that determinants of economic development are similar to the determinants of FDI, but this does not mean that there is a simple cause and effect between them.

In contrast to economic theory, the empirical evidence in SA shows that FDI flows at least in the past two decades, do not seem to be sufficient to generate overall economic gains and development. This seems to support the argument that the causal relationship between FDI and economic growth is neither direct nor automatic. Technological progress, human capital and financial market development are three major channels though which FDI is typically absorbed. Thus, in order to extract the potential benefits of FDI inflows, the absorptive capacity – the country´s ability to harness innovation and business opportunities through economic spill-overs – is a preliminary condition to translate FDI into effective and productive investments that lead to capital formation and employment creation.

A first step towards identifying bottlenecks to productive investment can ramp up the country’s absorptive capacity and unlock growth potential. These include, first of all, high levels of inequality which have discarded the majority of people from the potential benefits of FDI. Second, most FDI in South Africa is channelled into the export-oriented capital-intensive mining sector. Poorly developed downstream and upstream pipelines in the industry have weakened linkages between mining and other, more labour-intensive, sectors and therefore diminished spill-overs into employment creation and investments in capital formation. Thirdly, nearly two-thirds of South Africa’s economic activity is concentrated in just three out of its nine provinces, with most industrial and commercial activities taking place in and around major city-regions like Johannesburg, Pretoria, Durban and Cape Town. Many other parts of the country have inherent economic potential, but they need targeted investment if such potential is to be unlocked. Partially, this is because the available infrastructure, skills and institutional support in these regions are often woefully inadequate.

It could be argued that a key benefit of investing in regions with potential is that it leads to positive socio-economic spill-overs in surrounding areas. However, the scale of the spatial inequality problem in South Africa and the apparent inability of policy makers to tackle it head-on has meant that most secondary cities lack the requisite infrastructure, human capital and market densities to benefit from the potential spill-over effects of FDI inflows. The bottom line is that South Africa’s policy framework seems to be geared towards absorbing unskilled labour in primary industries outside secondary cities.

While we commend investment envoys for encouraging domestic investment, so that FDI follows, we need to cognisant that MNE (or FDI) activity is not a conditio sine qua non for development. In other words, there are preconditions associated with benefits. Whatever examples we follow, we should be conscious that countries are not the same. They have different strengths and weaknesses, different resources and endowments, different policies. Policy space is increasingly shaped by non-national economic actors (other countries, international organisations, civil society).

Narula implored us to honestly test the three conditions for benefits:

  1. Do the kinds of FDI being attracted generate significant spillovers?

  2. Does the domestic sector have the capacity to absorb these spillovers? It is worth adding (in the case of LDCs particularly) that there needs to be a domestic sector.

  3. Is the FDI that is being attracted a substitute or complementary to domestic industry?

Simply to ‘pump’ a country full of FDI will not catapult it to a higher stage of development,” he implores.

There are costs to FDI, and FDI can have significant negative effects. Does FDI matter? Does SA need FDI? The answer to both questions is affirmative. But not as much as making the conditions to learn from it, because the conditions for learning are the conditions for attracting higher quality FDI. Firms and industries have benefited from FDI because:

  1. They have technological capability to access resources in remote locations that are extremely difficult to access, and/or to explore and extract more value from subsoil assets that weaker counterparts would have abandoned.

  2. They possess an intricate knowledge of specialised markets and are able to organise themselves across a multitude of value chains in several locations.

  3. They have deep pockets and access to financial capital.

  4. They have strong political connections both at home and in the host country.

The “wrong” FDI is little more than a capital infusion at a higher cost than capital markets. If economic policy doesn’t look to build stable institutions and conditions for learning, FDI policy will not matter. As Ramaphosa’s lions look for FDI, the task is not limited to attracting FDI but equally to retain it through after-care as well as embedding same. DM