1. Introduction
The United Nations’ Sustainable Development Goals (SDGs) outline seventeen goals that developing nations must meet by 2030. The achievement of these goals will aid in reducing income inequality, poverty alleviation, and the advancement of human development. However, progress made towards these goals is uneven, with some countries meeting the majority of them while others failing to fulfil any of them. Similarly, most African countries are off-track in meeting these targets and require significant foreign capital to achieve these goals (
SDG 2019). In achieving these SDG goals, the importance of foreign direct investment (FDI) cannot be underestimated. This is because of its potential in transferring knowledge and technology, enhancing competition, boosting entrepreneurship and productivity, and increasing government revenue through taxes paid by foreign investors (
United Nations 2003). Many developing economies, particularly in Africa, have adopted FDI promotion policies as a result of the importance of FDI as a major source of external finance. In 2017, at least 126 investment policy actions and reforms were undertaken by about 65 economies around the world. These reforms include simplifying administrative investment procedures, liberalization of domestic markets, and establishing new special economic zones (SEZs) (for a complete description of these measures, see the 2018 World Investment Report).
This has resulted in a massive increase in FDI flow to Africa, which has increased from
$59.99 billion in 1990 to
$942.05 billion in 2019. (
UNCTAD Statistics 2020) Nonetheless, despite a significant rise in FDI inflows, poverty in the region continues to worsen.
Figure 1 shows that the number of people living in extreme poverty increased from 278 million in 1990 to 437 million in 2018 (
World Bank 2019). According to the World Bank, extreme poverty will become a largely African problem in the following decade, with the region accounting for the lion’s share of the world’s impoverished by 2030. While extreme poverty is prevalent in the region, nearly half of Africa’s poor people live in just five countries: Nigeria (79 million), the Democratic Republic of Congo (60 million), Tanzania (28 million), Ethiopia (26 million), and Madagascar (20 million). These statistics become even more worrisome when compared to the level of extreme poverty in other regions (
Schoch and Lakner 2020).
However, the theoretical underpinnings of the FDI–poverty nexus are far from being conclusive. For example, advocates of FDI (
Mankiw et al. 1992;
Hansen and Rand 2006),
Soumare (
2015);
Bharadwaj (
2014);
Fowowe and Shuaibu (
2014) take the view that FDI is welfare-enhancing/reduces poverty. The most obvious link through which FDI affects poverty is through job creation in the host countries (
Gohou and Soumare 2012). Beyond that, FDI also delivers a much-warranted transfer of valuable technology and know-how (
Javorcik 2015). This positive view of FDI is not universally shared among important scholars in this field (
Arabyat 2017;
Rye 2016;
Gohou and Soumare 2012). One of the most forceful non-proponents of this view is
Stiglitz (
2002), who argues that FDI is likely to be affected by market imperfections and unequal bargaining power that may elevate inequality and impede welfare enhancement strategies.
An emerging strand of literature argues that the extent to which FDI is welfare-enhancing depends very much on initial conditions or certain circumstances in the host country’s ‘quality institutions and a functioning financial system’ (
Arogundade et al. (
2021),
Yeboua (
2020),
Jude and Levieuge (
2017), and
Agbloyor et al. (
2016),
Lehnert et al. (
2013) and
Cleeve (
2012),
Fowowe and Shuaibu (
2014). What this means is that host countries with relatively good institutions and developed financial systems are likely to experience more welfare-enhancing effect of FDI compared to nations with poor institutions and less-developed financial systems. Reaching a similar conclusion, the theoretical framework of
Chenery and Stout (
1966) also provides the theoretical foundation for the importance of external capital flows for low-income countries. In an economy characterized by savings or foreign exchange gaps, the model claims that external finance can play a crucial role in boosting domestic resources.
In an IMF paper entitled, “Why Does FDI Go Where it Goes? New Evidence From the Transition Economies”,
Campos and Yuko (
2003) identify key factors that are crucial in attracting FDI. They write “countries with a large market, low-cost labor, abundant natural resources, and close proximity to the major Western markets would attract large amounts of FDI inflows. FDI would thus go to countries with favourable initial conditions.”
Derived from these theoretical augments, the broad hypotheses of our study are that (1) neighboring countries’ FDIs have a significant positive impact on the incidence and intensity of a host country’s poverty; (2) improved institutional quality in neighboring countries has a significant impact on the FDI–poverty reduction nexus of a host country.
The non-uniformity of the theoretical arguments highlights the need for more empirical research to further verify if FDI is welfare-enhancing or not. In fact, a brief review of empirical studies on the FDI–poverty nexus proved to be rather ambiguous. While some studies suggest that FDI has a positive impact on poverty reduction (
Sukhadolets et al. 2021;
Sikandar et al. 2021;
Magombeyi and Odhiambo 2018;
Ganić 2019), others suggest the opposite: a negative impact (
Ali et al. 2009). For example,
Sukhadolets et al. (
2021) studied the relationship between GDP, FDI, investment in construction, and poverty. The authors compared a number of countries such as the Russian Federation, including a sample of developed and developing nations. Using non-linear autoregressive distributed lag, the study found that investment in construction stimulates the economies of countries in the long term and maintains or reduces the poverty level by increasing the assets of the population.
Using pool mean group estimation techniques,
Sikandar et al. (
2021) investigated the impacts of six types of foreign capital inflows on the parameters of poverty reduction and agriculture development in the short-term and long-term perspectives across fourteen developing economies of Latin America, Asia, and Eastern Europe. The study found evidence to suggest that poverty reduction could be positively affected by an increase in the values of agricultural exports, foreign direct investment, foreign development assistance, and remittances received from migrant workers. In sharp contrast, using the autoregressive distributed lag (ARDL) model,
Ali et al. (
2009) found that FDI increased poverty in Pakistan both in the long-run and short-run. The reason for the conflicting results on the impact of FDI on poverty is that majority of these studies neglect the importance of space in their model. Ignoring the importance of spatial interdependence in regional empirical studies may result in either inefficient or biased estimates (
Anselin 2009).
While the application of spatial econometrics to FDI literature is still at the embryonic stage, some empirical studies have taken into account the role of third-country effects:
Gutiérrez-Portilla et al. (
2019) for Spain;
Do et al. (
2021) for Vietnam;
Madariaga and Poncet (
2007) for China;
Uttama (
2015) for Southeast Asia. These studies conclude that FDI in neighboring countries significantly influences the host country’s economy. To the best of this authors’ knowledge, this study is not aware of any literature that has specifically examined the spatial impact of FDI on poverty in Africa. The closest attempt is that of
Chih et al. (
2021). However, this study failed to account for the role of neighboring countries’ institutional quality on the nexus between FDI and the economy. The study also assumes that what is good for economic growth is also good for the poor. Since economic growth does not imply a reduction in poverty, it is essential we examine: (1) whether neighboring countries’ FDI matters on poverty reduction of the host country, (2) examine the spatial impact of institutional quality on the FDI–poverty nexus in Africa, and (3) determine whether there is a spatial spillover of poverty in Africa.
Doing this study for Africa is vital for the following reasons: (1) the region is challenged with poor welfare, and often termed the world capital of poverty. (2) The positive spillover of FDI in the region may be hampered by a poor institutional environment. As a result, attracting multinational corporations to invest in these conditions may not produce the desired benefits, as investment flourishes in a competitive atmosphere. (3) Since countries in this region belong to a regional organization designed to encourage mutual economic development among member countries, the level of economic activity in one member state may influence economic activity of another country.
The empirical findings from the spatial Durbin model indicate a significant spatial spillover of FDI on the incidence and intensity of poverty in Africa. The results further provide support for the significant role of institutional quality on the nexus between FDI and poverty reduction. Furthermore, the marginal effect results suggest that countries in Africa are not in isolation, i.e., the level of poverty in a particular country is influenced by its determinants in the neighboring country. This calls for a coordinated policy toward eradicating poverty and establishing institutional reform. The rest of this paper is structured as follows:
Section 2 provides stylized facts on FDI and the spatial pattern of poverty in Africa.
Section 3 houses the methodology and estimation techniques. The presentation and discussion of the empirical results is discussed in
Section 4, while
Section 5 concludes and provides critical policy implications.
2. African Poverty in Space
This section provides key stylized facts that motivate this study.
Figure 2 presents the contour map of headcount poverty across the 47 selected African countries. The map displays spatial clustering of poverty in 1996 and 2019. As shown in the map, there is evidence of higher clustering of poverty in 2019 compared to 1996.
The plots also show that countries such as the Democratic Republic of Congo, Central Africa Republic, Congo Republic, Angola, Zambia, Malawi, Mozambique, Rwanda, Burundi, and Madagascar are epicenters of poverty incidence in Africa in 2019, while countries such as Botswana, Gabon, Ghana, Mauritania, Algeria, Morocco, Tunisia, and Egypt have low poverty rates. In determining whether the incidence of poverty in one country influences the poverty incidence of other proximate countries, this study conducted local and global spatial autocorrelation tests. The former test, which is based on a specific Moran’s I statistic, identifies local “hot spots,” or in other words, the countries where strong spatial correlations exist. The latter test is based on the
Moran’s (
1950) I spatial autocorrelation statistic; this test determines whether poverty incidence globally observed depends on geographical distribution.
The null hypotheses of these tests suggest that poverty incidence in different countries is considered to be spatially independent. The p-value of the global autocorrelation test is significant, indicating the existence of spatial dependence (see
Appendix A Table A1). Similarly, the local indicators of spatial association (LISA) test identifies countries with strong spatial correlations in poverty incidence (see
Appendix A Table A2 for more). In addition to this,
Figure 3 presents the univariate Global Moran’s I statistic calculated from headcount poverty over the period of 1996 to 2019 for each country.
The Moran’s I correlation test, which indicates the degree of spatial autocorrelation, suggests a positive spatial clustering of poverty incidence.
2 Thus, we can conclude that there is spatial dependence of poverty incidence across African countries from 1996 to 2019. This evidence provides an impetus for the inclusion of space in this study.
Figure 4 shows a scatter plot of FDI and the incidence of poverty in Africa. The plot reveals that countries with relatively high FDI inflows are characterized with high incidence of poverty. However, countries with low FDI inflows are associated with low poverty rate. This indicates that the level of a countries’ foreign investment is positively correlated with the poverty rate. This is also consistent with the argument of
Rye (
2016) and
Arabyat (
2017), who argue that foreign investment increases poverty due to its crowd-out effect on domestic capital. This conjecture is perhaps meaningless and lacks objectivity if not subjected to empirical verification.
The scatter plot of the institution quality
1 and poverty rate is presented in
Figure 5. The figure reveals that countries with relatively high poverty incidence are characterized by poor institutional frameworks. However, countries with a robust institutional framework have relatively low poverty rate. Countries with sound institutions, such as efficient and good governance, low corruption, rule of law, and property rights, tend to improve the process of technology spillovers to local enterprises. On the other hand, countries with weak institutions may prevent indigenous enterprises from benefiting from multinational corporation (MNC) knowledge and technology spillovers (
Agbloyor et al. 2016;
Brahim and Rachidi 2014). Hence, the impact of FDI on poverty reduction is expected to vary between countries and regions with varying level of institutional quality.
6. Conclusions and Recommendations
In reducing the savings gap and achieving equitable and sustainable development, a large amount of quality foreign resources is required in Africa. Hence, foreign investments, such as FDI, are seen as one of the most important drivers of economic development in the region by policymakers. However, empirical studies examining the impact of FDI on poverty have reached varying results. While some studies argue that FDI reduces poverty, some studies believe that it increases poverty. Other studies posit that FDI’s impact is conditional on certain intermittent variables. The reason for the diverse findings on the impact of FDI is that the majority of these studies neglect the role of space. In contributing to the literature, this study assesses whether spatial interdependence/third-country effects matter in the impact of FDI on the incidence and intensity of poverty in Africa. In achieving this, the study employed the spatial Durbin model to quantify the impact of neighboring country FDIs on the poverty conditions of a host country. Before accounting for space in our model, the study conducted some pre-estimation tests to determine the existence of spatial spillover on the effect of FDI. The results indicate that neighboring country FDIs impact a host country’s poverty. Hence, neglecting spatial interdependence in the FDI model may result to biased estimates.
This study’s empirical findings are as follows: (1) neighboring country FDIs have a significant and positive impact on the incidence and intensity of the host country, (2) neighboring countries’ institutional quality matters in the nexus between FDI and poverty reduction, since the positive impact of FDI on poverty is mitigated through a robust institutional quality, (3) there is a significant spatial spillover of neighboring countries’ poverty to a host country, (4) the marginal effect results indicate that countries within the region are no longer in isolation or independent; i.e., the level of poverty in a particular country is influenced by its determinants in the neighboring country. This result is robust to the different proximity matrix, which is the inverse distance.
The empirical results of this study have produced important policy implications for African governments. First, since FDI does not reduce poverty from our empirical estimation, African countries need to embark on public sector reforms, as investment would not thrive when there is high corruption, low voice and accountability, government inefficiency, poor regulatory quality, low rule of law, and political instability. Second, since the empirical results of this study provide evidence of both direct and spillover effects of poverty determinants, we recommend that African countries consider their surrounding countries’ characteristics in their welfare policy formulation. The study also highlights the importance of joint task efforts toward building strong institutional quality. This is to permit African countries to have coordinated policies towards building a robust institutional framework. African governments through the African Union (AU) or other relevant agencies are encouraged to not only develop an institutional reform for Africa, but also establish a binding mechanism to ensure reform implementation.