The impact of international investment agreements on foreign direct investment in Africa

Abstract

Interest in foreign direct investment (FDI) stems from the fact that it has become one of the most important components of globalisation and a vital part of international economic and diplomatic relations. It rose to prominence after World War II to become an indispensable source of foreign finance globally, and has remained crucial for technology spillover, employment creation and economic growth in developing nations. One of the most common approaches that countries use to attract FDI has been through international investment agreements (IIAs), since they are theoretically hypothesised to provide an effective means for its inflows. In spite of the popularity of such IIAs in Africa, there are not many studies on their effectiveness in attracting FDI. This is the gap that this study has sought to surmount in order to advance recommendations that can guide policymakers on how to make decisions on investment treaties. To this end, the study aims to investigate factors that determine the treaty signing proclivity of African countries in the first part. It also aimed to assess the impact of IIAs and the role of the investment climate in mediating the relationship between IIAs and FDI in 50 African countries over the period 2000 to 2018. An aggregative measure of bilateral investment treaties (BITs)s was employed in the first phase, and dummy variables were used in capturing the presence of BITs with top investing countries in the continent and treaties with investment provisions (TIPs). Data on BITs and TIPs were collected from Policyhub, while data on FDI and control variables were collected from the United Nations Conference on Trade and Development and the world development indicators respectively. A one-way error components model was used to estimate the determinants of treaty signing proclivity, while the two-step generalized method of moments (GMM) was used within a monadic framework to examine the impact of IIAs on FDI in Africa. Results showed that combinations of poor institutional factors and market size were nontrivial determinants of investment treaty participation. Further results underscored the importance of bilateral investment treaties (BITs) in attracting FDI and also demonstrated their potency in landlocked and least developed countries (LDCs). Therefore, BITs meet their intended purpose of signalling, which translates into increased FDI. This effect is expected to significantly vary across African countries and the study recommends a few right BITs due to potential diminishing returns, among which those with the USA, South Africa and France can potentially have beneficial effects. Results regarding the impact of treaties with investment provisions (TIPs) showed that the effects of membership with the African Growth and Opportunity Act (AGOA) on FDI were contingent on market size and availability of good institutions. The effect of WTO accession on FDI was also contingent on the quality of institutions. The study also found robust evidence that different political institutions had varying effects on a country’s attractiveness to FDI and that BITs significantly substituted for weak political institutions. Therefore, IIAs are an important part of increasing FDI share in Africa because of the incentives they provide through the augmentation of the investment climate that has a strong signalling impact on foreign investors. However, countries should consider flexible IIAs that allow them to pursue their local development policies without interference.