An analysis of the relationship between FDI and economic growth in selected East African countries

Abstract

Over the last three decades there has been a significant increase in FDI flows across the globe. This attracted the interest to investigate the impact that such an increase in FDI has on the economic growth of a host country. Subsequently, the relationship between FDI and economic growth has become a widely controversial topic among researchers. Theoretically, researchers argue that FDI contributes to economic growth through cross-border technology and information transfer, increasing employment and increasing the skill capacity of a host country. However, this has been challenged by several researchers, arguing that too much FDI threatens domestic companies. East Africa has been on the receiving end of this phenomenon and has become one of the biggest FDI destinations on the African continent. Some East African countries have managed to successfully utilise the increase in FDI, which made the region even more competitive. As more East African countries are changing and implementing new investment policies to attract more foreign investors, this study investigates the impact of FDI on economic growth in selected East African countries. Using a fixed effects panel data analysis, the study first examined the data from 10 selected East African countries over the period 1998-2018. The overall findings show a positive relationship between FDI and economic growth in the selected East African countries. The results are in line with the predictions of similar empirical studies and growth theorists. The study then examined the influence of external factors on the FDI and economic growth nexus. The study found that the FDI and economic growth is vulnerable to external factors, highlighting the importance of a country’s economic structure. Lastly, the study examined whether the relationship between FDI and economic growth differs according to income classification, specifically low income countries and lower-middle income countries. The results show that the growth enhancing potential of FDI is greater in lower-middle income countries. As such, the economic structure and income classification of a country are deemed important growth enhancing factors. Given the importance of FDI for economic growth in East Africa, the study concludes by recommending that investment policies not only focus on attracting FDI, but also promote economic development. FDI can be a valuable development tool for East African countries if it is correctly utilised by the host country.