Multinational Enterprises, Foreign Direct Investment and Growth in Africa: South African Perspectives (English)

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Multinational Enterprises, Foreign Direct Investment and Growth in Africa

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Bernard Michael Gilroy • Thomas Gries Willem A. Naude Editors

Multinational Enterprises, Foreign Direct Investment and Growth in Africa South African Perspectives With 31 Figures and 22 Tables

Physica-Verlag A Springer Company

Series Editors Werner A. Miiller Martina Bihn Editors Prof. Dr. Bernard Michael Gilroy Prof. Dr. Thomas Gries Department of Economics University of Paderborn Warburger StraBe 100 33098 Paderborn [email protected] [email protected] Prof. Dr. Willem A. Naude Director of WorkWell Research Unit People, Policy and Performance North West University Private Bag X6001 Potchefstroom 2520 South Africa [email protected]

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88/3130/DK-5 4 3 2 1 0 - Printed on acid-free and non-aging paper

ACKNOWLEDGEMENTS

This publication is the result of a research project, supported by the South African National Research Foundation (NRF) entitled "Entrepreneurial Networks, Human Skills and Multinational Firms in Labour Market Adjustments to Globalisation". The financial assistance of the National Research Foundation: Division for Social Sciences and Humanities towards this research is hereby acknowledged. Opinions expressed and conclusions arrived at are those of the authors and are not necessarily to be attributed to the National Research Foundation. The authors are also grateful to the Southern African-German Chamber of Commerce and Industry and the German Business Group at KPMG, Johannesburg for their assistance and advice, as well as the many German firms in South Africa that participated in the study. A particular word of thanks is due to Professor Klaas Havenga, former Dean of the Faculty of Economic and Management Sciences from North-West University, and Professor Karl-Heinz Schmidt of Paderborn University, whose farsightedness in stimulating co-operation between the two universities across two continents not only resulted in this research project and publication, but also in a formal collaboration agreement between Paderborn University and North-West University that was signed in May 2001. This book is dedicated to them. All views contained in this paper are that of the authors alone.

Willem Naude, Thomas Gries & Bernard Michael Gilroy POTCHEFSTROOM, SOUTH AFRICA PADERBORN, GERMANY August 2004

CONTENTS

INTRODUCTION B. M. Gilroy, T. Gries, W. Naude

1

Part I Africa in the Global Economy 1 ON GLOBAL ECONOMIC GROWTH AND THE CHALLENGE FACING AFRICA T. Gries, W. Naude

7

2 CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs T. Gries

37

3 THE DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN AFRICA W. Krugell

49

4 THE GLOBAL INTEGRATION OF AFRICA: The EU-SA Free Trade Agreement and German MNEs in South Africa W. Naude, W. Krugell, N. Bauer

73

Part II Multinational Enterprises in Africa 5 THE CHANGING VIEW OF MULTINATIONAL ENTERPRISES AND AFRICA B. M. Gilroy

101

6 GERMAN MULTINATIONALS IN AFRICA B. M. Gilroy, N. Bauer

155

VIII

CONTENTS

7 OBSTACLES FACING GERMAN ENTERPRISES IN SOUTH AFRICA B. M. Gilroy et al

197

8 COMPETITIVE INTELLIGENCE IN A FOREIGN ENVIRONMENT: GERMAN AND CANADIAN FIRMS COMPARED J. Calof, W. Viviers

209

Part III Labour Market Adjustment, Foreign Direct Investment and Human Resource Development 9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT: A Theoretical Analysis with Heterogeneous Labour T. Gries, S. Jungblut

229

10 HUMAN RESOURCE DEVELOPMENT: A SINE QUA NON FOR FOREIGN DIRECT INVESTMENT IN SOUTH AFRICA W. Naude, W. Krugell

247

11 CONCLUSIONS B. M. Gilroy, T. Gries, W. Naude

279

APPENDIX

285

ABOUT THE CONTRIBUTORS

303

INTRODUCTION B. M. GILROY, T. GRIES and W. NAUDE

How can Africa, the world's most lagging region in economic development, benefit from globalisation and achieve high and sustained economic growth rates so as to achieve the international development goal of reducing the number of its inhabitants in poverty by 50% by 2015? In this we proceed from the standpoint that Africa needs much greater investment by multinational enterprises (MNEs) to improve its competitiveness, to develop its comparative advantages and fast-track growth through the positive spill-over effects associated with the activities of global firms. The challenge for African countries at the beginning of the 21 st Century is how to be a more desirable destination. However, the relationship between foreign direct investment (FDI), the behaviour of MNEs and economic growth in Africa may not be well understood. For instance, despite the fact that Africa's returns on investment averaged 29 percent since 1990 (exceeding that of countries like Japan, the US and UK), Africa has gained merely 1 percent of the global FDI flows. This book is based on a research project aimed to better understanding the reasons for this and asks the question: How can Africa be a more desirable location for MNEs? Much of the current research emphasis in the international research community has been on the macro-economic policy conditions for African growth. Only recently, mainly due to household surveys designed to track poverty (e.g. in Ghana) and the work of the World Bank's Regional Programme on Enterprise Development (RPED) to understand how firm-level behaviour is affected by trade liberalisation did our knowledge of the microfoundations of growth in Africa improve. However, whilst household surveys and surveys of African firms are immensely insightful, in a rapidly globalising world economy where MNEs play a dominant role it is necessary to combine insights from household and firm-level surveys with the role and impact of MNEs in Africa. To do this the current study integrates three currents of economic research, namely from the literature on (endogenous) economic growth, convergence

2

B. M. GILROY, T. GRIES and W. NAUDE

and regional integration, the explanations for Africa's poor growth and the growing understanding of the role of MNEs in a global economy. We develop a model of human skills, foreign direct investment and catching-up that could be relevant for Africa. The empirical side of the analysis is based on an econometric study of the determinants of FDI in Africa as well as a detailed firmlevel survey of 31 German firms in South Africa that were conducted in 20001. In addition to expanding the knowledge of MNEs in Africa, and identifying the constraints on German firms in South Africa, this study also expands the understanding of the geography of MNEs in general. The behaviour and contribution of MNEs in Africa has perhaps not been well understood in the theoretical literature and this study is an attempt to rectify this shortcoming.

A SOUTH AFRICAN PERSPECTIVE In attempting to answer the difficult question raised in the previous paragraph, we will be taking a South African perspective in the sense that this book is based on a joint research project between the Universities of Paderborn in Germany and North-West University in South Africa. German MNEs have been investing in South Africa for well over a century and South Africa is one of the top five destinations for FDI on the African continent. South Africa provides a particularly fruitful viewpoint from which to study the inflows of FDI by MNEs into Africa. Firstly, it is one of the few African countries that have significantly liberalised its current and capital accounts over the past five years, and achieved a remarkably stable macro-economic position. Easy access, possibilities for profit repatriation and macro-economic stability together with the country's good physical and financial infrastructure suggest therefore that it should be at the forefront of receiving inflows of FDI. However, this has not been the case, and the one unfulfilled requirement in the new government's "Growth, Employment and Redistribution" (GEAR) macro-economic strategy has been the inability to achieve sufficient inflows of FDI. In chapter 10 of this book, we detail the South African experience with FDI inflows in the context of a model that links human capital with FDI inflows. Although this is a South African viewpoint, the implications for the rest of Africa could be argued to be very valid as it emphasises the importance of certain specific micro-foundations for growth such as adequate human capital. 1

Germany provides almost 40 percent of South Africa's imports. There are around 560 German firms in South Africa employing more than 65 000 people. Most of these enterprises can be identified to operate in the secondary sector especially in the machinery, electronic, chemical, pharmaceutical, automobile and metal production sectors. Also important are some 90 SMEs in these sectors, followed by 68 businesses operating in the tertiary sector. The average German firm has been operating in South Africa for 22 years.

INTRODUCTION

3

The South African viewpoint is not only of interest to the rest of Africa. It may also contribute to the current concerns in OECD countries about the implications of trade liberalisation and globalisation for employment growth and employment diversion. The Economic Journal devoted its 1998 Policy Forum to trade and labour market adjustment, noting the marked increases in unemployment and wage differentials between skilled and unskilled labour. Concerns about trade and labour markets have become a "preoccupation" in the OECD and developing countries alike since "with increasing capital mobility and technology diffusion, the quantity and quality of domestic labor forces are ever more important determinants of comparative advantage". Particularly in Germany, globalisation had resulted in firms raising their competitiveness through innovation, with less employment opportunities (especially amongst lower-skilled occupations) being created.

CHAPTER OUTLINE This book contains three broad sections with 10 chapters and a concluding chapter that summarises the main findings. Part 1 identifies the need in Africa for higher levels of FDI inflows in order to catch up with the rest of the world. A model is provided for understanding the roles of FDI in catching-up. In this model, that will be refined in section three (chapter 9) to allow the employment impact of FDI to be studied, the roles of technological upgrading, innovation and human capital formation are emphasised. Section one also investigates the determinants of FDI in Africa through an econometric model and concludes by studying how greater openness in African economies can be established through free trade agreements with higher-income countries. This type of openness is argued to be good for FDI. Part 2 describes the theory of MNEs and provides an examination of the role of MNEs in economic growth through technology and skills transfers and a broad investigation of the role of German MNEs in Africa. Specifically, the historical background and influences of colonialism upon the international production strategies of MNEs in Africa is discussed with a special focus on German MNEs and their activities in South Africa. In this section, the results from the survey of German firms in South Africa are analysed with reference to the large body of existing research on economic growth and multinationals studied in section one and two. The role of German MNEs in South Africa is also examined to determine the behaviour with respect to training, innovation and outsourcing. It is found that German MNEs have an important role in South Africa in terms of employment, innovation, transfers and spillovers but that most of these firms, especially medium-sized firms, are subject to significant constraints. These constraints relate mainly to the labour market,

4

B. M. GILROY, T. GRIES and W. NAUDE

and for that reason section three deals with human capital and labour market adjustments to globalisation. Part 3 approaches the contribution of MNEs and FDI in Africa and South Africa from the crucially important point of human capital and labour market adjustments. The impact of globalisation on labour markets in South Africa is modelled and the human resource development requirements for FDI to lead to positive job creation is analysed.

Part I

Africa in the Global Economy

ON GLOBAL ECONOMIC GROWTH AND THE CHALLENGE FACING AFRICA T. GRIES*1 and W. NAUDE2 1 2

University of Paderborn, Germany [email protected] North-West University, South Africa EBNWANOpuknet. puk. ac. za

1.1 INTRODUCTION Africa remains the world's poorest region, both in absolute and relative terms, at the dawn of the 21 st century. The final decades of this century had been a decade of lost growth for much of the countries of Africa3.The prediction of neoclassical growth theory that poorer countries such as Africa might "catch up" - i.e. converge in per capita income terms with richer countries, has proven over-optimistic. Indeed, most African countries have fallen behind during the 1980s and 1990s. By 1997 average per capita incomes in Africa (outside South Africa) were only US $1045 (expressed in real terms of purchasing power) (Gelb, 1999). On average, real per capita GDP did not grow in Africa over the 1965 - 1990 period, while, in East Asia and the pacific, per capital GDP growth was over 5 percent (Easterly & Levine, 1997). During the 1980s the decline in per capita GDP was 5 percentage points below the average for all low-income developing countries. As the decline accelerated during the 1990s, the gap widened to 6.2 percentage points (Collier & Gunning, 1999). In light of the significant contributions made to economic growth theory by the "endogenous growth" literature the purpose of this chapter is to utilize the insights from that literature, as well as more empirical insights from the literature on Africa's economic performance to attempt to answer two related questions. Firstly, can African countries attain sufficiently high economic growth rates to catch up in per capita income terms with other developing countries? If so, what are the policy changes required to achieve these growth rates? The answers to these questions will also throw light on the extent to which policies aimed at "globalising" African economies are appropriate.

*Some of this material has been previously presented in Welfens, Addison, Audretsch, Gries, Grupp (1999), pp.41-72. 3 The notable exceptions are Botswana and Mauritius.

8

T. GRIES and W. NAUDE

In section 2 the problem of Africa's falling behind is illustrated with reference to global patterns of economic growth. Section 3 is an attempt to integrate economic growth theory and the empirical literature on Africa's economic performance in order to identify the determinants of Africa's potential for catching up. Section 4 concludes.

1.2 GLOBAL ECONOMIC GROWTH AND DIVERGENCE A peculiar characteristic of world economic development is the variety of average growth rates across countries during the latter half of the 20*^ century. Figure 1.1 shows the distribution of average growth rates for a sample of 123 countries over the period from 1960 to 1992. Since the figure covers a period of thirty years the variety in average growth indicates substantially different growth regimes. The lowest average growth rate is -2.2, the highest 7.3, and the mean is 1.9 percent. The difference of roughly 10 percentage points between the highest and lowest average growth rate indicates the heterogeneity of growth experience across nations over the last three decades. Only 51 countries, about 41 percent, have growth rates in between one percentage point above or below the mean. For 14 countries the average growth rate is even negative - most of which are African countries. Roughly 16 percent of the economies were not able to increase their income per capita in absolute terms.

number of countries

'Xk %

h.

-3%to -2%to -1%to 0%to1% 1%to2% 2%to3% 3%to4% A"/< -2% -1% 0% Source: SUMMERS and HESTON (1993), Penn World Table 5

3 6% 6%to7% 7%to8%

Fig. 1.1. Average Growth Rates (1960-92) Apart from growth rates the level of income per capita is another important indicator to consider. If a country with a lower income level has a higher

1 GLOBAL GROWTH & CHALLENGE FACING AFRICA

9

growth rate than another country with a higher income level, both economies will converge. The idea of convergence and divergence is extensively used in recent empirical and theoretical studies on growth. In most studies two different concepts of convergence are considered, J-convergence and /3-convergence. For additional definitions of concepts see Quah (1993). If there is a negative correlation between the average growth rate and the initial income per capita, ß -convergence will occur. In this case economies with lower income levels tend to grow faster than rich ones. .. •' . / ••Club5

• *

0 400

600

-0,02

800

1000

income I percapita 1200 1 9 6 0 ' intern. — j prices

-0,04 Source: SUMMERS and HESTON (1993), Penn World Table 5

Fig. 1.2. Average Growth Rate of Income vs. Initial Income per Capita Figure 1.2 plots the 1960 level of income per capita against the average rate of growth over the period 1960 to 1992. There seems to be a lack of correlation between the initial level of income and the average rate of growth. The nonappearance of (absolute) convergence for broad samples of countries is now widely accepted in the empirical literature (see Fuente, 1997, for a detailed discussion). Not all countries will eventually converge to the same steady state. Therefore a further refinement has proved to be useful, the distinction between absolute and conditional convergence. Absolute convergence means that all economies are able to reach the same level of income and productivity no matter what initial condition they have. Conditional convergence means that a process of catching up occurs only within a group of countries characterized by similar initial conditions. Thus, only countries or regions with

10


comparable fundamentals will approach similar levels of income per capita and productivity. Countries with different fundamentals will diverge to different steady states. In referring to Africa's ability to catch up or not, this paper is referring to conditional converge. This requires that African countries be clubbed together according to initial per capita incomes, similarly as is done by Baumol (1986). Using the initial income per capita and the average growth rates given in figure 1.2, countries that are close together in the scatter diagram will form a club. Therefore, economies of a specific club will have similar developments of the level of income per capita. Regardless on how these countries have formed clubs there will always be countries that do not belong to any of these clubs. The figure shows that countries with average growth in between zero and four percent can be grouped into at least four additional subgroups. Altogether a total of six groups can be identified: Club 1, "the income elite", consist of the leading countries which have the highest initial income per capita in 1960. The members include Australia, Luxembourg, New Zealand, Sweden, Switzerland and the USA. The average growth rate of these countries is about 2% (for New Zealand it is lower). The economies from Club 2, "the industrialized catching up countries", have a lower initial income per capita, but a higher average growth rate than the leading elite. Thus, the income levels of these economies tend to converge to the leading countries. Typical members are Canada, (West) Germany, Netherlands, France and Italy. Countries from the remaining four clubs have similar initial income levels, but are distinguished according to their average growth rates. Club 3, "the strongly catching up countries", has the highest average growth rate. Typical members are the newly industrialized countries (NICs), like Korea, Hong Kong, and Taiwan, or countries like Japan, Malta, and Portugal. The economies of Club 4, "the slowly catching up countries", still have a higher average growth rate than the leading economies, but they are not as dynamic as the NICs. This club includes countries such as Tunisia, Syria, Turkey and Brazil. Economies of clubs 5 and 6 have lower average growth rates than the leading elite and hence, tend to diverge. Most African economies fall into these two clubs. Countries of Club 5, "the slowly falling behind countries", have positive average growth rates, but less than two percent. In this club are African countries such as Cameroon, Congo, and Kenya. Finally, mainly African economies like Central Africa Republic, Haiti, Mali, Niger, Zaire, and Zambia have negative growth rates and form Club 6, "the strongly falling behind countries". These economies diverge not only in relative terms, but also in absolute terms.


11

As a first stylized fact it can be stated that the industrialized countries (Club 1 and Club 2) and newly industrialized countries (Club 3) have a tendency to converge. The first view suggests that poorer economies of these clubs have higher growth rates than richer economies. A number of empirical studies confirm that for these countries the conditional convergence hypothesis holds (see e.g. Sala-I-Martin (1996), Quah (1996) or Fuente (1997)). The lower a country's income per capita the higher is the expected growth rate. But, it has to be emphasized that the evidence for -convergence is strongly dependent on the chosen group of countries (Fuente, 1997). Using data for 16 countries like Madison (1987) a strong negative correlation between the average growth rate of the economy and the initial income per capita can be found. This does not hold though for a less homogeneous group of 23 countries suggested by De Long (1988). Using the latter sample, the situation is less obvious as the correlation between the average growth rate and the initial income is rather weak. But, it has to be emphasized that the negative correlation between the initial income level and the average growth rate for the sample of 31 countries that form the clubs 1 to 3 is very clear.

1.3 UNDERSTANDING AFRICA'S DIVERGENCE Why do African countries tend to be either members of club 5 or club 6? To offer a satisfactory explanation, an encompassing theory is needed to explain the complete variety of growth processes of different countries or clubs of countries. This section utilizes traditional and new growth theories to explain the characteristics of the global growth process, and judge the relevance thereof for Africa given the rising consensus on the empirics of Africa's economic performance. 1.3.1 The Traditional &: Augmented Solow-Model The traditional neo-classical growth theory of the Solow (1956, 1957), Swan (1956) type regarded technological progress as exogenously given. Technologies are equally available without costs in every country. As a result global convergence is predicted. Countries are expected to converge to steady states determined by the rate of technological progress, savings and population growth. Testing the traditional Solow model Mankiw, Romer and Weil (1992) found that the effects of the saving rate and population growth are overestimated. Further, the traditional model is not able to explain observable differences in the level and growth rate of income across countries unless unreasonably high capital shares are used. Thus, the predictions of traditional neo-classical growth theory do not correspond with the stylized features of the global growth process.

12


Therefore, Mankiw, Romer and Weil (1992) introduced a new interpretation. They augmented the standard Solow model by including accumulation of human capital. The emphasis to include human capital is not new. Kendrick (1976) estimated that more than half of the total capital stock of the USA in 1969 consisted of human capital. Introducing human capital Mankiw, Romer and Weil (1992) show that the extended model provides a good explanation of the differences in the countries economic performance. Due to human capital the impact of the saving and population growth rate decrease. Or, to be more precise, if human capital accumulation is included and countries have different rates of accumulation and population growth, the implications of this extended Solow model cannot be rejected easily by the empirical facts. For a diagnosis of Africa's poor economic growth performance, the above theoretical contributions suggests that Africa's endowment of human capital and the investment rate in African countries, seem to be important factors determining growth opportunities. With reference to figure 2 it can be established that the "catching-up" countries of club 3 do have high endowments of human capital and high investment rates while falling behind countries tend to have low human capital and low investment rates. Considering the extent of human capital and fixed investment in Africa, it is firstly clear, from public expenditure data, that public investment in human capital, as a share of potentially productive government expenditure to GDP, is high in Africa. It would thus appear that the provision of education services has not been markedly worse than elsewhere. Africa has a lower stock of education than other regions, but a faster rate of growth of the stock. However, in many cases in Africa the implementation of education policies is deficient. One cause is that many policies are never implemented. When they are, wage expenditure (e.g. on teacher salaries) are prioritised over non-wage recurrent expenditure, to the detriment of delivery (Collier & Gunning, 1999). Secondly, regarding fixed investment in Africa, it is stated by Collier and Gunning (1999) that in order to achieve higher economic growth African countries ought to raise their investment rates. They state (p.42) that, "there is evidence that both a lack of investment response and bounce back are currently important. While the growth rates of the African reformers are currently similar to pre-crisis East Asia, investment rates are around 9 percentage points lower". Several empirical studies in labor economics suggest that human and real capital are poor substitutes in the production process. In a survey on human capital Hamermesh (1986) states: "Perhaps the most consistent finding is that non production workers (presumable skilled labor) are less easily substitutable for physical capital than are production workers (unskilled labor). Indeed, a number of the studies find that non-production workers and physical capital are p-complements. This supports Rosen (1968) and Griliches (1969) results


13

on capital-skill complementary hypothesis" (Hamermesh 1986). Later studies also correspond with these findings. Barro (1991) reports that investments in education and physical capital are positively correlated. In various studies, e.g. by Barro (1991), De Long and Summers (1991) or Levine and Renelt (1992) it has been established that the significance of education in growth regressions is reduced when investment in physical capital and other elements are included. Therefore Fagerberg (1994) concludes that countries should not invest in either education or physical capital, but in both assets. There may be evidence that in many African countries the type of physical and human capital investments made do not achieve or result in better complementarity between human and physical capital. The share of potentially productive government spending to GDP in Africa is high, but service delivery is inefficient. The case of deficient education services has been discussed as part of the lack of human capital in Africa. Physical infrastructure in Africa is also lacking in quality and quantity. In many cases the price of infrastructure is high which increases private cost, discouraging growth. A possible explanation of the deficiency of public services is firstly a lack of social capital. In other words, when low levels of civil liberties are found - as in many African countries - ordinary people are denied a channel of popular protest when public service performance worsens. When considering social-political indicators 4 such as measures of corruption, quality of bureaucracy, enforceability of contracts, civil wars, ethno-linguistic fractionalisation, social development and inequality, Africa is found to be short of social capital (Easterly & Levine, 1997 and Collier & Gunning, 1999). Possible reasons for this include ethno-linguistic fractionalisation and a lack of representativeness of government. Africa is highly fractionalised. Easterly and Levine (1997) measures fractionalisation by the probability that two randomly selected individuals in a country will belong to different ethno-linguistic groups. According to this, fourteen of the fifteen most ethnically heterogeneous societies in the world are in Africa. Such ethnic diversity increases polarisation. In turn, polarised preferences lead to a low provision of public goods, as it impedes agreement on the provision thereof. It also creates positive incentives for growth reducing policies, such as financial repression and overvalued exchange rates. 4

Easterly & Levine (1997) and Ghura (1995) mention the number of assassinations as a possible indicator. Bloom and Sachs (1998) uses five sub-indices to measure the quality of institutions. These include rule of law that reflects the degree to which the citizens of a country are willing to accept the established institutions to make laws and adjudicate disputes. There are a bureaucratic quality measures of the autonomy of the bureaucracy form political pressure and the strength and expertise to govern without drastic changes in policy or interruptions in government services. Measures of corruption in government reflect whether illegal payments are generally expected throughout government in the form of bribes connected to import and export licenses, exchange controls, tax assessments, police protection or loans.

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Ethnic diversity may also create rents for groups in power, at the expense of society at large (independent bribe-takers). The effects are even more significant in societies lacking political rights. This is of particular significance in Africa. In 1998 only 13 percent of the population lived in countries where legislators had been chosen in contended multi-party elections. This lack of representative government along with minority ownership of the modern part of the economy led to damaging economic control regimes and uncoordinated and competitive corruption (Collier & Gunning, 1999). A further explanation for the perceived low return on physical investment in African countries is because the public sector is used to create employment, and that reduces efficiency (Collier & Gunning, 1999). The resulting lack of complementarity between physical and human capital is often posited as a reason why physical capital is not flowing from the rich countries to capital-scarce countries in Africa. For instance Gries (1995a,b) analyses the role of human capital accumulation in the international allocation of goods and capital and finds that if human and real capital are complements, the domestic availability of human capital may determine the rate of domestic physical investments. The degree to which human capital can act as a complement to physical capital depends in part on the skills of the labour force (Gries, 1995a). A skill relates to the ability to use a certain technology. Technologies are embodied in capital goods: A certain capital good embodies a certain technology by the productive properties of the machinery. Hence the technology defines the link between human capital and real capital. This fixed link implies that a country with a certain human capital stock and structure will efficiently employ the adequate stock and structure of real capital. Accumulated local human capital determines the local requirements of real capital. A country is identified by the country's "characteristic endowment", namely the local abundance of human capital and labour. The endogenously determined human capital accumulation determines comparative advantages, the pattern of specialization and trade, and the direction of real capital flows. If the stock of accumulated human capital is small, little real capital is needed in domestic production. For a given world interest rate the required real capital is absorbed from internal and external sources. The domestic excess supply (demand) of real capital is provided to (taken from) the world markets. Thus, a region that accumulated little human capital will attract little real capital. The lack of domestic opportunities to invest will channel wealth accumulation to world markets. A capital outflow can be observed even for a poor region with little capital endowment, as is the case for Africa.


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1.3.2 The New Growth Theory The key factor in the "new growth theory" is human capital. But unlike in the extended versions of the traditional theory, human capital is not just accumulated. The new growth theory has identified human capital as an important factor that induces positive externalities, scale economies and innovations. On aggregate spillovers between firms and the multiple uses of techniques and skills in different fields give human capital almost the character of a public good. These positive externalities affect the production processes and generate increasing returns to scale at the aggregate level. With some special additional assumptions about the production of human capital or the creation of new technological knowledge, these models can generate endogenous growth processes. Technological progress is now endogenously generated. While a model of endogenous growth was first suggested by Uzawa (1965) the idea of human capital externalities was developed by Romer (1986, 1990a, 1990b), Lucas (1988) and extended and modified by Azariadis and Drazen (1990), King and Rebelo (1990), Rebelo (1991), Grossman and Helpman (1991b) and others. Several causes for increasing returns to scale have been introduced (Backus, Kehoe and Kehoe (1992)). For instance Arrow's learning by doing (Arrow (1962)) was used by Lucas (1988, ch.5) and Young (1991). The role of R&D or education as a source of endogenous growth, was suggested by Lucas (1988), Stockey (1991) or Romer (1987, 1990a,b), Grossman and Helpman (1991b), Aghion and Howitt (1992). Africa's geography, rural nature, and the nature of rural social capital can be identified in this vein as possible reasons for weak mechanisms for endogenising economic growth. For instance consider first the case of Africa's geography as explaining low levels of R&D, learning by doing and generation of increasing returns to scale. The climate, soils, topography and disease ecology of Africa negatively influences its agricultural productivity (Bloom & Sachs, 1998), transport costs and terms of trade (Naude, 2001). Africa, in particularly, sub-Saharan Africa has the highest proportions of land and population in the tropics. In all parts of the world, economic development in tropical zones lags far behind that in temperate zones. The underlying reason is a backlog in productivity growth. Differences in productivity growth and innovation between temperate and tropical zones reflect the interplay of a number of factors. First, many kinds of agricultural and construction technologies do not transfer well between ecological zones, making learning by doing difficult. Second, temperate zones have long had much higher rates of endogenous technological change than the tropics. Third, the tropics pose inherent difficulties in agriculture and public health. Fourth, the tropics are disadvantaged because they are far from large mid-latitude markets. Problems

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of transport costs are acute for African countries, both within the continent and between it and the rest of the world. It can be argued to prevent the establishment of production runs that can achieve economies of scale. As geography curtails productivity growth and the adoption of technology in Africa, growth is constrained (Naud, 2001). Considering the case of inadequate rural social capital to generate endogenous growth the first aspect that has been observed in African societies is that the traditional rural system is characterized by high costs due to forgoing specialization. The "forced" saving for consumption smoothing that this requires may force members to reduce capital accumulation. Government intervention, aimed to change the agricultural economy through the links between property rights and social learning and growth, has seen mixed results. Conferring marketable property rights to small farmers did not always succeed in overriding the traditional system and land transactions are limited (Tanzania, Mali, Niger, Nigeria and Ghana). In some instances traditional land rights did evolve toward marketability, but not enough to support investment. Investments remained unnecessarily illiquid and this reduces growth. Property rights also had a negative effect on inter-household resource allocation because hereditability created divergence in factor endowments and reduced growth. Specialization and trade in land were however insufficient to offset the negative effects. Social learning is the second mechanism whereby social capital was to affect growth through endogenising growth. In Africa, however, peer groups are small and segmented by gender. This provides little access to information that leads to innovation (Collier & Gunning, 1999). 1.3.3 Endogenous Growth and Openness to Trade There is a large "endogenous growth" literature dealing with the effects of international integration and international openness to growth processes (see Young (1991)). The reason for the importance of international integration and international openness is due to the fact that developing countries, such as those in Africa, can in most cases only enhance their technological knowledge by adoption of techniques developed outside of their country. The imitation of existing techniques instead of own innovation is the distinguishing feature between the growth processes of technological leaders and follower. Generally speaking countries at the middle or the lower end of the technological ladder face an advantage of backwardness (Abramowitz, 1979; 1986; 1992; 1993; Gomulka, 1991). The underlying idea is that technologically backward countries have a second mover advantage compared to innovating countries. This idea was first stated by Veblen (1915) and adopted by Gerschenkorn (1962). The advantage of backwardness is partly due to the fact that imitation is generally associated with lower risks, lower human capital requirements, and lower research expenditures than innovation activities. The


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potential to use existing and mature technologies for products in later phases of the product cycle offers the chance for a process of technological catch up due to imitation. This is especially true for countries at the middle or upper stage of the technological ladder. These countries may easily transform technological advantages into higher growth rates of productivity and therefore rapidly converge to the technological frontier of the leading economies. As the technology is taken from abroad there must be a channel to get hold of the international technologies. The idea that trade and economic integration tends to increase growth is supported by a number of empirical studies (see e.g. Michaely, 1977; Krueger, 1978; Balassa, 1978; World Bank, 1987; Helliwell, 1992; Edwards, 1992; and Dowrick, 1994). There are more ambiguous findings and the subjective classification of trade regimes as well as the sensitivity of coefficients may be criticized (Lai, 1993; Levine & Renelt, 1992). Nevertheless, the overall conclusion from the empirical literature tends to support the positive influence of open trade to growth. The empirical findings are supported by further theoretical considerations. Trade and imports as a diversified bundle of goods enable the country to get hold of modern technologies incorporated in imported goods. As a result a high degree of integration and high export shares are important preconditions for technological convergence. Another important argument why open economies usually face higher growth rates is that of higher competition in the markets of goods and services. Since competition is one of the predominating motivations for the adoption of advanced techniques, outward oriented economies are forced to use more modern and more efficient techniques than economies following a strategy of import substitution. A closely related argument is based on the consideration that trade is one of the dominating sources of technology transfer. Developing and newly industrializing countries are forced to import technology intensive intermediates and products. Although these products are mainly used for production purpose, they also offer a substantial chance to accumulate foreign knowledge by means of reverse engineering and imitation. Even in branches not able to compete with international suppliers positive spill over in terms of personnel and organizational knowledge frequently occurs. Therefore trade flows generate substantial external economies and thus strongly interact with the technological gap of a country. The reverse implication is that a lack of foreign exchange may heavily burden or even prevent the process of economic and technological upgrading. Nevertheless, a high degree of openness is not sufficient for technological upgrading. Backward economies must not only have access to modern technologies but also bring up resources necessary to efficiently absorb techniques available from abroad. Any technique is characterized by a variety of factors like the capital intensity, the scale of production, the mix of skilled and unskilled workers, and complementary services, just to mention a few. In gen-

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eral, technologies coming from industrialized countries will often not match the conditions of less developed countries. Therefore the degree of technological congruence and capability compared to the leading countries becomes a central issue for the process of technological upgrading (Abramowitz, 1992, 1993). As far as international integration is concerned, the first papers in this field investigated growth effects from integration for symmetric countries (Grossman & Helpman, 1991a; Rivera-Batiz and Romer, 1991a,b). In the symmetric case, integration will have positive growth effects. Integration increases total knowledge and due to rather special assumptions the growth rate in both countries will increase. In contrast, Rivera-Batiz and Xie (1992, 1993) found that in the asymmetric case integration may reduce growth rates. The latter result is not too surprising. In countries with human capital abundance, integration will intensify the production of manufactured human-capital intensive goods. This increasing production of manufactured products will shift skilled labor from the research sector to manufactured industry. The reduced human capital in the research sector decreases growth rates. Thus, following "new growth theory" the effects of globalization for growth of African countries that integrated with other countries cannot be unambiguously predicted. If openness may be beneficial for export growth, the literature seems fairly inclined to the view that higher export is good for growth. Michaely (1977) used Spearman rank correlation and found a positive relationship between exports and economic growth and that a minimum level of development is required for exports to benefit growth (see also Heller and Porter, 1978). Balassa (1978) found that exports have a positive effect on economic growth over and above the contributions of domestic and foreign capital and labour. Krueger (1981) found that export promotion strategies may not always generate export growth, but policies to encourage import substitution may retard export growth. Tyler (1981) stated that a positive and significant relationship exists between economic growth and manufacturing export growth. Kavoussi (1984) examined the effect of export growth on total factor productivity and found that a positive relationship is sensitive to the share of manufactured goods in total exports. Ram (1985,1987) found that exports are important for growth, also in low-income less developed countries. Moschos (1989) in fact suggested that a stronger positive relationship exists between exports and growth in low-income countries, compared to middle and higher-income countries. Concerning the direction of causality, Chow (1987) finds unidirectional causality where exports promote economic growth and structural transformation of the economy. Bhomani-Oskooee et al (1991) determined that there is a positive causality from export growth to economic growth for countries that are well known cases of successful export promotion strategies. Dodaro (1993) argues that in poor less developed countries the direction of causality will be from economic growth to export growth and in more advanced less de-


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veloped economies, from export growth to economic growth. In specific trade policy studies, Dollar (1992) determined that outward orientation accelerates the technological development of the economy and a significant positive relationship exists between growth and outward orientation. Edwards (1992) concluded that more open economies with less distortive trade policies tend to grow faster. Venables (1996) supported this and claimed that trade liberalisation triggers expansion of output equilibrium. From the above literature the reasons for the positive associated between openness, higher exports and higher economic growth may be due to the following. Firstly, from an allocational point of view, exports are argued to improve the allocation of resources in terms of comparative advantage (Ram, 1987). Allocational gains stem for the possibility of international specialisation (Tyler, 1981). Enlargement of the effective market size generates a number of technological benefits (Krueger, 1981). Indivisibilities in production are overcome, firms can use the minimum efficient plant size, utilise all capacity and exploit economies of scale (Balassa, 1978; Feder, 1982; Jung & Marshall, 1985 and Moschos, 1989). In addition, trade introduces international competition (Chow, 1987). There is competitive pressure to reduce X-inefficiency, (Jung & Marshall, 1982), and it necessitates technological improvements (Ram, 1985 and Moschos, 1989) and more efficient management (Feder, 1982). Thus, exports tend to increase total factor productivity (Balassa, 1978). These benefits also spill over to non-exported products that can then be produced more efficiently (Tyler, 1981). However, the marginal productivity between the export and non-export sectors differs and it is likely to be higher in the export sector (Feder, 1982). That is because the effect of export expansion on productivity growth is also sensitive to the share of manufactured goods in total exports. A shift to manufactured exports enhances the effects of exports on productivity (Kavoussi, 1984). In conclusion, exports can thus promote resource allocation to the more productive manufacturing sector, while having advanced comparative advantages that promote export and economic growth (Chow, 1987). Secondly, from the perspective of a two-gap model of development exports relax the foreign exchange constraint on growth (Ram, 1985). It is possible to use external capital for development without problems in servicing the debt (Dollar, 1992). That allows for increases of imports of productive intermediate inputs (Jung & Marshall, 1985) and promotes capital accumulation and growth (Dodaro, 1993). More open economies have the advantage of absorbing technological innovations generated in advanced nations (Edwards, 1992) and of the subsequent expansion in education and innovation (Eicher, 1999). The result is a higher level of income and a higher long-run rate of growth. Given the role of openness and growth discussed above, the arguments put forward can be used to evaluate the extent to which a possible lack of openness and success in exporting can be held responsible for Africa's economic

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divergence. The failure of African countries to penetrate export markets successfully, particularly in manufactured products, is clear from the fact that Africa's, and in particular sub-Saharan Africa's share of world trade fell dramatically over the past forty years. The region's share of world exports declined from 3.1 percent in 1955 to 1.2 percent in 1990. There was also major erosion of the region's ability to compete in international markets and Africa lost ground in key commodity exports (Ng & Yeats, 1998).5 There are a number of possible explanations for this lack of export success. The first is changes in Africa's ability to compete internationally. A general deterioration in Africa's competitive position is reflected in the 42 percent reduction in exports, below what would have occurred if only for demand changes (Ng & Yeats, 1996). Teal (1999) contributes the low level of competitiveness to Africa's low levels of skill and relative abundance of natural resources, which make exporting manufactures unprofitable. Furthermore, African governments created a high transaction costs environment that constrained export growth, while policy failed to promote the technological capabilities that are needed for successful industrialisation. Changes in demand conditions also provide an explanation for the poor trade performance. For Africa the demand factor was lower than for any other country group. In addition, Africa also became dependent on a relatively small number of commodities. Thus, it experienced declining market shares for its major export products, which were of declining relative importance in international trade (Ng & Yeats, 1996). Ng and Yeats (1998) identifies four factors that should also be taken into account to explain a county's trade and growth performance. The first is the level and structure of trade restrictions encountered in major export markets. For Africa, Teal (1999) found very little evidence that OECD trade protection caused the general loss of competitive position, reflected in Africa's declining market shares. The second is the domestic trade policy implemented by the country itself. Teal (1999) finds that African trade barriers are far more restrictive than that of any other region. The divergence in the case of non-tariff protection is even sharper. This has an adverse influence on exports and economic growth as tariffs on production inputs are high and place domestic producers at a substantial direct cost disadvantage compared to the fast growing exporters. Ng and Yeats (1998) proposes that government policies affecting the general business climate and the ability of local firms to exploit opportunities in foreign and domestic markets, as well as the physical characteristics of the country also influence trade and growth and should be taken into account. Inappropriate and often inconsistent macro-economic policies, lack of strong 5

Rodrik (1998) emphasises that one should keep in mind that there was a variety of performance within the region.


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political and social institutions, social capital and financial depth, as well as adverse geography in Africa have already been discussed.

1.4 THE CATCHING-UP PROCESS The reasons for Africa's divergence have been outlined using the standard and new economic growth theories in section 3. This section attempts to provide an understanding of the catching-up process itself, in order to identify the economic growth strategies that African countries should follow in order to at least prevent further diverging from the global economy. It is argued in this section that multinational enterprises (MNEs), through their function of integrating global production structures through foreign direct investment (FDI) may have a key role to play in the catching-up process. The link between the importance of MNEs and catching-up growth is provided by one of the most innovative contributions in the new growth literature, namely the modeling of innovations on a firm level. With the endogenous "production" of technological progress diverging growth processes in different countries can be explained. The internal accumulation and allocation of resources - especially of human capital - determines the R&D activities, the technological ability and finally the productivity growth rates of a country. Therefore, growth opportunities are determined endogenously and the countries preferences determine the growth position. It is therefore the mechanics of new growth theory that suggests why growth processes may differ and divergence can be observed. The probably most important factor responsible for the technological capability is the stock of real and human capital available to the economy. The predominating role of human capital endowments can be explained by several theoretical ideas. Many of the points made by the "new growth theory" concerning the role of human capital for innovations will hold for imitations as well. Sufficient human capital is a precondition for a successful adoption and use of advanced technologies in a country. This proposition is supported by a number of empirical studies (see e. g. Fagerberg, 1994). The conclusion that can be drawn form the empirical literature is that the countries that tended to catch up are those with a high initial level of human capital and high investment rates (Baumol et al., 1989; Barro, 1991). Verspagen (1991) also finds that countries with low social capabilities (proxied by education) run the risk to be caught in a low growth trap. In addition, the complementarity of human capital to technology in the processes of research and production is commonly suggested in the literature (see OECD (1996) for a discussion). In section 3 it was shown that African countries started out with insufficient levels of human capital, and closed economies that prevented the inflow of investment and foreign technology.

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If a country meets sufficiently favorable conditions - integration and sufficient human capital - a process of technological upgrading begins. Because the country can rely on technological knowledge already available from outside, it will be able to realize higher productivity growth rates than countries at the technological frontier. As a result the countries technological gap will diminish. Africa's divergence in this view is thus to a large extent due to a growing technological gap between it and the rest of the world. If one sees catching up to require as a minimum that the technological gap be closed, then the process of catching up can be roughly divided into four different phases. These phases can be exemplified by the economic development of the eastern Asian countries. At the beginning the process of upgrading will be relatively slow due to the missing technological congruence as well as the low endowment with human capital compared to the leading economies. But in a second phase, if the country is able to assimilate higher incomes into the additional accumulation of physical and human resources, the process of upgrading may become self sustained or even accelerate. After a period of rapid convergence the third phase starts. This phase is characterized by a slowdown of technological progress and growth. The slowdown is due to counteracting forces rooted in the process of upgrading. Although the country is now able to adopt more and more advanced techniques the set of technologies available for imitation will continuously diminish as the technological gap becomes closed. Therefore resources necessary for imitation will increase relative to gains in productivity. The last phase is characterized by a process of convergence and essentially determines the final technological position relative to the leading countries. Countries that do not bring up the internal and external conditions for upgrading are unable to use their comparative advantages as technological followers. Therefore, these countries will stagnate or even diverge (Gries & Wigger, 1993). Foreign Direct Investment (FDI) is an important channel - and possibly at the current stage the only channel for African countries - to adopt advanced technologies. But in reality only a few countries are obviously able to support their process of upgrading by means of foreign real and human capital investments. The reason is that technologically backward countries are not only characterized by higher returns on investment compared to industrialized countries but also by a high default risk due to unstable technological and social environments. The premium necessary to compensate this risk will tend to counterbalance the return differential or - in the worst case - exceed it. This might explain why most FDI take place within the industrialized elite. In addition to the industrialized elite only a few countries are actually able to substantially attract international capital flows, especially the Eastern Asian economies forming club 3. This observation suggests that capital flows - FDI - importantly interact with the technological gap of a country.


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FDI will generally tend to speed up the process of technological upgrading because it raise the rate of capital accumulation and offer additional access to advanced techniques. Therefore upgrading economies have a good chance to attract additional capital through FDI that in turn tend to speed up the process of catching up. In the debate on the strategies open to African countries to speed up economic growth, the role and nature of MNEs and FDI is relatively understated (see eg Collier and Gunning, 1999). It is important to note that the importance of MNEs in economic globalisation is due to their functions in providing Foreign Direct Investment (FDI) and of leading to growing intra-firm trade (Welfens, et al., 1999:3). Although African countries remain amongst the most "closed" economies in the world6, many have begun to implement trade liberalisation programmes and adopted outward-orientation as a growth strategy (see e.g. Gelb, 1999a;1999b). FDI and the benefits of intra-firm trade, given that international technology transfer is primarily in the form of intra-firm deals, may thus hold significant growth-benefits to Africa as a whole. Rising FDI and involvement of MNEs could stimulate economic growth in Africa to the extent that it facilitates micro-economic, structural changes required for the African economic environment to become more "investment friendly". It is the type of benefits that FDI and MNEs could impart that could be beneficial in this regard to Africa within a global economy, namely technology spillovers, international technology trade, improved use of know-how and a higher overall investment-output ratio (Welfens, et al., 1999:v). A possible policy/co-ordination problem that may exist is that the above requirement may imply that Africa is locked into a low-growth equilibrium, whereby FDI/MNEs are required to create the conditions favourable for investment in a global economy, but that FDIs/MNEs do not perceive Africa as a desirable investment destination at present, despite promising macroeconomic reforms and growing trade liberalisation. For instance, despite the fact that returns on FDI in Africa was almost 60% higher than that in other developing regions during the period 1990-94, it attracted less than 2% of all flows to developing countries by 1995 (roughly US $2bn. Per annum, exc. South Africa) (see Jaspersen, et al., 1998; Bhattacharya, et al., 1996).

1.5 CONCLUSION This chapter provided the basic research question to which a partial answer will be sought in the chapters that will follow. This question also motivates the recently announced New partnership for African Development (NEPAD)7 6

See Sachs and Warner's (1995) broad definition of closedness and openness in an economic context. 7 See www.nepad.com

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proposed by South Africa, Nigeria and Algeria. The question is, can African countries attain sufficiently high economic growth rates to catch up in per capita income terms with other developing countries? In a context of increasing globalisation, this chapter found that Africa requires investment by multinational enterprises (MNEs) to improve its competitiveness and to facilitate micro-level structural changes required to reduce its riskiness as an investment environment. In the debate on the strategies open to African countries to speed up economic growth, the role and nature of MNEs and FDI is relatively understated. It is important to note that the importance of MNEs in economic globalisation is due to their functions in providing Foreign Direct Investment (FDI) and of leading to growing intrafirm trade. Although African countries remain amongst the most "closed" economies in the world8, many have begun to implement trade liberalisation programmes and adopted outward-orientation as a growth. FDI and the benefits of intra-firm trade, given that international technology transfer is primarily in the form of intra-firm deals, may thus hold significant growthbenefits to Africa as a whole. Rising FDI and involvement of MNEs could stimulate economic growth in Africa to the extent that it facilitates microeconomic, structural changes required for the African economic environment to become more "investment friendly". It is the type of benefits that FDI and MNEs could impart that could be beneficial in this regard to Africa within a global economy, namely technology spillovers, international technology trade, improved use of know-how and a higher overall investment-output ratio. Hence, Africa might be in low-growth equilibrium trap, unless factors and conditions can be identified such that MNEs can become more involved in African economies.

8

See Sachs and Warner's (1995) broad definition of closedness and openness in an economic context.


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CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs T. GRIES* University of Paderborn, Germany Thomas.GriesQnotes.uni-paderborn.de

2.1 INTRODUCTION As discussed in the previous chapter, the global growth process is rather heterogenous. There may be certain clubs of countries with similar growth experiences like catching-up clubs or groups that are falling behind. Many African countries experienced a process of relative divergence towards the leading individualized country group. Some Sub-Saharan countries suffered from even decreasing per capita income. This chronic failure of economic growth during the last two decades was not typical for Africa. As Collier/Gunning (1999) point out, in the 60s, Africa's growth prospects were encouraging. By 1950 Africa had overtaken Asia and between 1960-73 a booming economy was going along with decolonialization. Today, 32 countries are poorer now than in 1980. Today, Africa is the world's region with the lowest income. Looking at these facts many contributions in the literature try to identify the obstacles for a dynamic growth in Africa. What caused the decline in growth rates? Internal and external factors as well as policy made problems and exogenous destinies are suggested. Sachs/Warner (1997) and Gallup/Sachs (1999) emphasized adverse external destiny factors for African people like the fact of being atypically landlocked or an adverse climate. Others like Collier/Gunning (1999) stress more on poor or even counterproductive domestic policy activities. And Ndulu/O'Connell (1999) or Deaton (1999) try to identify some interactions between external factors and negative domestic policy outcomes. In this book we will not be able to conclude in this discussion. Our interest is more limited. We just focus on the role of FDIs for the development process in (South) Africa. Therefore, before turning to the more micro and firm oriented chapters it seems favorable to introduce a short theoretical model which may give an idea of the major development mechanisms and the effects of the domestic factors as well as FDIs on the catching-up process.

*The theoretical model of this chapter traces back to Gries (2002)

38

T. GRIES

The theoretical model of this chapter will focus on three problems: (i) We must introduce a model with a stylized development mechanism, which captures the empirical observed regimes of catching-up as well as fallingbehind. That is, the model should allow to identify the conditions for a switch from stagnation to dynamic upgrading. (ii) The model should clearly distinguish between the contributions of domestic factors and external factors on growth and development. (iii) The model should be able to identify the effects of FDIs on the development process and draw a general picture of the potential role of FDIs for development. In our model the developing economy will be modeled as a small open economy in the economic neighborhood of industrialized countries. The human resources of the economy are defined as the major domestic factor of production. For simplicity this human factor will be called human capital. Even if as Schultz (1999) pointed out - the literature on aggregate evidence of human capital returns to growth has a number of shortcomings, there is little doubt, that "...the available evidence does tend to show that higher initial levels of education tend to be associated with more rapid subsequent growth." Schultz (1999 p.72.) Further, in our model human capital stands for a broad concept of human abilities as discussed by Schultz (1999). Human Capital is the central domestic economic factor. There are two sectors, a final good sector and R&D sector. As the country is backward the R&D sector is describing the imitating process. In other words, the process is not a research and developing process as it is known in an industrialized country. Imitation includes all learning and spill over effects that are leading to increasing productivity on aggregate. The presence of foreign firms, and their communication and exchange with the domestic economy is the channel of foreign know how and new ideas in the domestic imitation process. Therefore, foreign direct investments, human capital and technological spill over effects are important factors for the production of the final good as well as for the imitation of technologies. Successful catching-up requires the closing of the technological gap towards the leading countries of the industrialized world. Like the new growth theory this paper emphasizes the importance of technological diffusion and the accumulation of human capital as the main sources of income growth. Technological diffusion through direct investments and the ability to use technologies in production determine growth opportunities.

2 CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs

39

2.2 THE MODEL The representative African economy is a small open economy integrated into world markets. The economy is characterized by a technological gap towards the industrialized world in the phase of economic catching-up. The economy consists of two sectors, a production sector and a research and development sector. The inputs of production are real capital and human capital denoted K and H respectively. FDIs are regarded as the only source of real capital accumulation. The production function for the final product is described by the Cobb-Douglas X = Ka{THx)l~a.

(2.1)

where X denotes the output and Hx the amount of human capital used for the production of goods. T is the technological efficiency depending on the state of technological knowledge available in the economy. Since the economy is technologically backward, it does not create new knowledge, but acquires new technologies by adopting foreign designs. The process of adopting foreign technologies consists of three elements: •

Foreign direct investments enable the country to get hold of so far unknown production and organization methods. FDIs indicate international links and can channel knowledge into the backward country. Therefore, technological advance is positively related to the flow of FDIs. FDIs are generally used to increase technological abilities.

•

Technologies embodied in FDIs have to be unveiled. FDIs can improve and speed up technological progress, but technological progress still needs other domestic resources. The process of adoption will use human capital.

•

The ability to increase the domestic stock of technological knowledge is positively related to the technological gap between the backward country and the industrialized world2. If the domestic stock of knowledge is low, it is relatively easy to increase knowledge by adopting foreign knowledge. But this process becomes increasingly difficult as the technological gap diminishes.

2 This in fact is the well-known Veblen-Gerschenkron-Hypothesis which states that at the outset of a catching-up process simple technologies will be copies, which can be easily imitated while later on more sophisticated technologies have to be unveiled. For a formal model including trade and structural change see Gries/Jungblut (1997).

40

T. GRIES

Thus, we assume that the country's internal rate of technological progress T can be described as

f = K0{eHT)1-0.

(2.2)

where K denotes the growth rate of the stock of real capital as a result of FDIs, HT = H — Hx is the amount of human capital used in the R&D-sector and is an index of technological backwardness. The index of backwardness is defined as 1 — w with w = T/V and V as the state of technological progress in the industrialized world. The resources devoted to the research sector are regarded as a constant fraction 7 of GDP: PTT

= 7K

(2.3)

PT is the price of adopted technologies and T = ^ . Y denotes GDP and is defined as

Y = PTf + X. Thus, the value of copied technologies can be derived as

T^X-

(2 4)

-

Since we want to focus on FDIs, we do not assume domestic capital accumulation. The flow of foreign direct investments / = K is determined according to the arbitrage condition r = Srw,

(2.5)

where r denotes the rate of return of FDIs, rw the world's interest rate and 5 > 1 a risk premium factor. Later we will discuss how a change of ± caused by political crisis will affect growth opportunities of a country. The marginal return of FDIs is given as

4 Thus we receive K = X. Further, using equation (1) to derive the growth rate of output we get X = aK + (1 — a)T and therefore K =f

(2.7)

The efficient allocation of human capital requires identical marginal products in both sectors | ^ = 9^T which is equivalent to


41

(2-8)

Using equation (9.4) to substitute for the right hand side of this equation we can solve for H,=c,H

with

d :=

( 1

_^y^\_7)

(2.9a)

F r = c2F

with

c2 :=

(1_ffl^g;)(1_7)

(2.9b)

and

Thus the allocation of human capital is constant over time. Equations (7) and (9b) can be used to substitute for K and HT in equation (2). The resulting equation can be solved for T as t = c29HT.

(2.10)

While domestic knowledge is endogenous, the technological progress of the industrialized world is assumed to grow with a constant exogenous rate n: V = nV.

(2.11)

Therefore, the time path of the relative technological position, w = y , is given by T v W = f - yW

Using Equations (10) and (11) yields w =(&- n)w - $"w2

(2.12)

with $ := c2H It is possible to solve the logistic differential equation (12) explicitly. The solution can be derived as (2.13) and WQ = w(0) as the initial value of the relative technological position. This solution suggests the possibility of two different dynamic regimes for the time path of technological upgrading depending on \P.

42

T. GRIES

W(t)'

final } technology gap

100%

Fig. 2.1. Technological Convergence and Divergence Path (a) For 0/ < n the ratio of technological knowledge w(t) will converge to zero, i.e the country cannot close the technological gap and will diverge (see figure 2.1, case (a)). (b) For #• > n the ratio of technological knowledge w(t) will increase and the country will follow a s-shaped process of technological upgrading. But, even in the long run a final gap 1 — — will remain and the country cannot fully close the technological gap without switching from imitation to innovation (see figure 2.1, case (b)).

2.3 RESULTS What are the most important determinants for the path of development and the final position of the economy? (i)The role of the domestic factor, human capital: For given values of a, f3 and 7 the condition ^f > n can be expressed in terms of the minimal human capital requirements necessary for successful upgrading: H>

(1-/3)7

(2.14)

Therefore, the process of technological upgrading will only be successful, if the country meets the human capital requirements given in condition (14). The critical endowment of H must be higher, the higher the rate of international technologies progress n. The value of \P = &(H) is not only important at the beginning of the upgrading process, but also determines the final technological position

2 CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs limt^oo w(t) = 1 - £

43 (2.15)

Since the GDP path has the same property as the path of technological upgrading, the economy will only catch-up in terms of GDP, if human capital is abundant (see (iii)). The higher the endowment with human capital, the smaller the final technological gap. The final technological gap remains as long as the economy does not change from imitation to innovation. This switch is not covered by the model. Here we describe imitation and adoption of foreign designs. Innovation processes are quite different to imitation processes. Modeling innovations would be much more complex. In addition we also would have to take more care of describing human capital as being creative rather than technical, (ii) The role of FDIs for technology upgrading: Equations (14) and (15) show that the flow of foreign direct investments does neither influence the critical level for technological convergence nor the final technological position of the economy given in figure (2.1). The link between FDIs and technological capabilities is given by K = T. Thus, foreign direct investments can only accelerate technological growth as long as the economy converges, i.e. T > n. Although FDIs are important for the process of catching-up the switching condition for upgrading as well as the final level of the technological position is solely determined by the stock of domestic resources. The human capital endowment of the economy is eventually the critical factor. This theoretical finding goes along with empirical findings by Bin Xu (2000). In this study for US multinational enterprises Bin Xu found out: "the level of human capital is crucial for a country to benefit from technology spill over of MNEs. These results are also consistent with the findings of single country studies that the technology spill over effects of MNEs are positive in advanced countries and insignificant in less developed countries" [Bin Xu (2000) p. 491]. The analysis therefore points out that the role of FDIs may be generally overestimated, especially with respect to the question if a country is able to take a path of convergence. On the other hand, FDIs are often not just the inflow of foreign capital and the embodied technology. Some times the host country is not able to provide sufficient technical and managerial knowledge to operate the sophisticated foreign capital. Therefore, in many cases multinational firms send a bundle of factors containing real and complementary human capital. If this additional human capital would significantly contribute to the total stock of domestic human capital, the critical endowment could be reached. In this case FDIs and complementary inflowing human capital would push the economy on a convergence path. (iii) The role of FDIs for the GDP growth path: In our model FDIs are important with respect to the GDP path. Equation (2.13) determines the

44

T. GRIES path of technological upgrading of the economy (see Figure 2.1). Using (2.1), (2.4), (2.5) and (2.6) the path of GDP can be derived as

Since the leading industrialized countries grow at the constant rate n, their GDP can be expressed as Yw(t) = c^Vit) where c3 is constant. Thus, the relative GDP level of the modeled economy is given by y(t) = ^=cd^w(t)

with c:= T ^( g ^)T^fiiJ

As a result the path of the relative GDP of the country has the same properties as the path of technological upgrading. Therefore, the economy will fall behind in terms of GDP, if the economy is technologically falling behind (& < n). In this first case the relative GDP of the economy will finally converge to zero. This case might be relevant for African economies during the last two decades. As long as African economies are unable to provide sufficient domestic human capital a dynamic take of process is not likely to start. A critical level of human capital defines the turning condition for successful development. The second case (& > n) was relevant for the East Asian economies during the last two decades and may also draw a perspective for future development of African Economies: Economies in the process of technological upgrading will catch-up toward the leading industrialized countries (see Figure 2.1, case (b), solid line). The path of the relative GDP will be s-shaped. But, even in the long run these economies will not be able to fully close the GDP gap as long as the technological gap remains. Analyzing the s-shaped path of convergence two phases have to be distinguished. During the first phase growth is much higher than the growth rates of the leading industrialized countries. In the second phase of catching-up the forces of deceleration lead to decreasing growth rates, as the advantage of backwardness of the upgrading economy diminishes. Thus, the speed of technological upgrading reduces. (iv) Growth effect of the destabilizing politics and political risks: Due to political crisis investing in these economies becomes more risky. The increasing uncertainty leads to a rising risk premium in the model. A high risk premium 82 > di (a low level of FDI) reduces the steady-state path of GDP of the economy (see Figure 2.2). If the economy is able to technological upgrade ((\P > n)), the economy will switch to a lower GDP path at time £0 a n d finally approach a lower steady-state. Thus, due to a higher risk premium the GDP gap increases. The steady-state path of GDP will reduce and the economy will finally reach a lower GDP position.


45

100%

Fig. 2.2. Growth Effects of Increasing Risk and Uncertainty

2.4 CONCLUSION By introducing a simple formal model we tried to give an idea of a stylized development process of an African economy with special attention to the role of FDIs. As the country is underdeveloped the R&D sector is describing the imitating process. Foreign direct investments, human capital and technological spill over effects are important factors for the production of the final good as well as for the imitation of technologies. It is shown that the economy will face a divergence regime as long as the domestic factor, human capital endowment, is below a critical level. Although FDIs are important for the process of catching-up the switching condition for upgrading as well as the final level of the technological position is solely determined by the stock of domestic resources. Without a sufficient domestic factor, no take off to a dynamic catching-up process takes place. Therefore the results emphasize the importance of the domestic factor. The role of FDIs may be generally overestimated, especially with respect to the question of convergence or divergence. Having reached this critical level of human capital, the process of upgrading towards the industrialized world is not linear, but s-shaped. Successful catching-up requires the closing of the technological gap towards the leading countries of the industrialized world. FDIs are important for the level and speed of GDP growth. Therefore, political risks and increasing uncertainty will lead to a decreasing level of FDIs and will reduce the path as well as the steady-state income level of the economy.

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REFERENCES Barro, R. J. (1990). Government Spending in a Simple Model of Endogenous Growth, Journal of Political Economy, Vol. 98, 5, part II, 103-125. Barro, R. J., LEE, J. W.(1993). International Comparisons of Educational Attainment, Journal of Monetary Economics. 32, 363 - 94. Barro, R.J., Sala-i-Martin, X. (1995). Economic Growth, New York: McGrawHill. Bin Xu (2000). Multinational Enterprises, Technology Diffusion, and Host Country Productivity Growth, Journal of Development Economics, Vol. 62, 477 - 493. Collier, P., Gunning, J. W. (1999). Why Has Africa Grown Slowly?, Journal of Economics Perspectives, Vol. 13, Number - Summer 1999, 3-22 Collier, P., Gunning, J. W. (1999). Explaining African Economic Performance: Journal of Economic Literature, March, 37(1), 64-111. Deaton, A. (1999). Commodity Prices and Growth in Africa, Journal of Economic Perspectives - Vol. 13, Number 3, 23 - 40. Gallup, J. L., Sachs, J. D. (1999). Geography and Economic Growth, in: Proceedings of the Annual World Bank Conference on Development Economics. Pleskovic, Boris and Joseph E. Stiglitz, eds. World Bank, Washington, DC. Gries, T. (2002). Catching-Up, Falling Behind and The Role of FDI: A Model of Endogenous Growth and Development, The South African Journal of Economics, Vol. 70(4). Gries, T., Jungblut, S. (1997). Catching-Up and Structural Change, Economia Inter-nazionale, Vol. L, 4, 561-582. Gries, T., Wigger, B., Hentschel, C. (1994). Endogenous Growth and R &D Models: A Critical Appraisal of Recent Developments, Jahrbucher fur Nationalokonomie und Statistik, Vol. 213, 1, 64-84. Grossman, G. M., Helpman, E. (1991). Innovation and Growth in the Global Economy,Cambridge MA: MIT Press. Lucas, R. E., Jr. (1988). On the Mechanics of Development Planning, Journal of Monetary Economics, Vol. 22, 1, 3-42.


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Ndulu, B. J., O'Connell, S., A. (1999). Governance and Growth in SubSaharan Africa, Journal of Economics Perspectives - Vol. 13, Number 3 Summer 1999, 41- 66. Romer, P. M. (1986). Increasing Returns an Long-Run Growth, Journal of Political Economy, Vol. 94, 5, 1002-1037. Romer, P. M. (1990). Endogenous Technological Change, Journal of Political Economy, Vol. 98, 5, part II, 71-102. Sachs, J. D., Warner, M. (1997). Sources of Slow Growth in African Economies, Journal of African Economies, 6, 335-76. Schulz, T. P. (1999). Health and Schooling Investments in Africa, Journal of Economic Perspectives - Vol. 13, Number 3- Summer 1999, 67 - 88.

THE DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN AFRICA W. KRUGELL* North-West University, South Africa

3.1 INTRODUCTION Africa faces significant challenges in low growth, persistent poverty and high inequality. The Economist of 24th February 2001 refers to an "elusive dawn" in Africa, as African leaders' Millennium African Renaissance Programme confronts war, disease, corruption and half of sub-Saharan Africa's 600 million people living in absolute poverty. It may be argued that foreign direct investment (FDI) presents a possible solution to the growth and development challenges in Africa. FDI supplies capital and provides for spillovers of foreign technology and know-how to host economies. This may aid growth and development. Currently many African governments are reshaping their policy frameworks in an effort to attract FDI. Yet there has been little empirical work done on the determinants of FDI in Africa. This chapter provides a theoretical and empirical analysis of the determinants of FDI in sub-Saharan Africa. Theories of the internationalisation of production are used to outline the reasons why multinational enterprises (MNEs) undertake FDI. These reasons help to identify the conditions and policies that might draw FDI to Africa. The empirical analysis tests for the significance of a number of hypothesised determinants of FDI, in sub-Saharan Africa. The pooled cross-country and time series estimation covers the period 1980 to 1999 for 17 countries. The results show the importance of economic growth, domestic investment and macroeconomic stability, for attracting FDI.

* Lecturer in the School of Economics, Risk Management and International Trade, at the North-West University, Potchefstroom, South Africa. The chapter is based on work undertaken for the MSc dissertation at the University of Warwick in 2001. The author would like to thank Kim Scharf and Wim Naude for their helpful comments. The usual disclaimer applies.

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Section 2 introduces the challenges facing African countries and presents FDI as a possible solution. The case is made for the significance of identifying the determinants of FDI in Africa. In section 3 the theory and evidence of the determinants of FDI are examined. Dunning's (1993) OLI-theory serves as the basis for current thinking on the determinants of FDI. The overview of recent empirical findings shows the importance of economic variables such as market size and wage costs as determinants of FDI. The empirical analysis for sub-Saharan African countries is presented in section 4. Section 5 provides some conclusions and recommendations.

3.2 THE POTENTIAL ROLE OF FDI IN AFRICA The so-called African development "tragedy" defines the continent's lack of growth, and limited development. Over the last four decades Africa has been the only region where per capita income fell, while the average global per capita income doubled (ADR, 2000). In Africa an estimated 350 million people live on $1 per day or less. Ranked by Human Development Index, eighteen of the world's twenty lowest ranked countries are in Africa (World Bank, 1999). Although the African economic scene of the late 1990s offers some hope of recovery in a number of countries, the challenge remains that of accelerating broad-based economic growth for development. FDI has been put forward as a possible solution to this challenge. FDI is an amalgamation of capital, technology, marketing and management2 (Cheng & Kwan, 2000). Over the past twenty years international production and FDI has grown rapidly. At the end of 1999 the global stock of FDI stood at $5 trillion. The ratio of world FDI inflows to global capital formation was 14 per cent in 1999 - compared with 2 per cent twenty years ago. The role of foreign capital in developing countries has grown in accordance with the global trends. In 1999 developing countries received $208 billion in FDI. That constituted an increase of 16 per cent over 1998 and an all-time high (WIR, 2000). These FDI flows are argued to benefit growth and development. In host countries, labour is combined with domestic and foreign owned physical capital in the production process. FDI affects growth directly by increasing the stock of physical capital - new inputs supplement those in the production process. Investment drives capital accumulation, which drives growth. FDI affects growth indirectly through effects concomitant with greater openness: technology spillovers and knowledge transfers (De Mello, 1999). Technology spillovers from TNCs promote technological upgrading in the host 2

For measurement purposes FDI refers to net inflows of investment to acquire a lasting management interest (ten per cent or more of voting stock) in an enterprise operating in an economy other than that of the investor (Hawkins & Lockwood, 2001).

3 DETERMINANTS OF FDI IN AFRICA

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country. This leads to process innovations whereby old goods are produced using newer technologies. FDI induces human capital development through knowledge transfers. The existing stock of knowledge in the recipient economy is augmented through labour training and skill acquisition and diffusion. Knowledge transfers may also take the form of alternative management and organisational arrangements. Technology and human capital also have productivity spillover effects by which FDI leads to increasing returns to domestic production (Stoker, 2000). This promotes growth in the long run. In practice, however, the distribution of international production and the benefits associated with it, is unequal. Developed countries receive nearly three-quarters of the world's FDI flows. Only 10 developing countries receive approximately 80 per cent of total FDI flows to the developing world. Net private capital flows to Africa are only a small portion of the total. Africa's share of FDI flows is small and has been declining (Chaudhuri & Srivastava, 1999). In 1985 Africa received a 3.1 per cent share of worldwide FDI flows. This declined to 2.3 per cent in 1997 and 1.2 per cent in 1998. Inflows rose from $8 billion in 1998 to $10 billion in 1999, but that was not enough to increase the African share and it remained at 1.2 per cent (WIR, 2000). These limited flows should not be taken to indicate that Africa has little investment potential, or that FDI can make only a limited contribution to growth and development. There are a number of arguments to the contrary. •

Although Africa's share of FDI flows has fallen in comparison with other regions, the flows have been positive (UNCTAD, 1998). The aggregate data belies the fact that a number of African countries are doing well. Recently, low-income countries like Uganda and Tanzania have been able to sustain gradual increases in FDI inflows (WIR, 2000).

•

The FDI that does take place is becoming more diversified. Diversification is being aided by the opportunities created by privatisation programmes (WIR, 2000). It is not the absolute size, but the relative size of the inflows that should be examined. Many African economies are small and when inflows are measured per capita, or per $1000 of GDP, several countries are faring considerably better than the average for African countries and some even better than the average for developing countries. Examples include Guinea, Seychelles, Angola and Botswana (UNCTAD, 1998).

•

The potential for attracting FDI exists, as FDI in Africa is profitable. A study of United States affiliates in Africa over the period 1980 to 1993 shows that the rate of return on FDI in Africa was considerably and consistently higher than the average for developed and developing countries (UNCTAD, 1998).

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In policy circles, the arguments in favour of a role for FDI in African growth and development are not only being made, they are also being acted upon by African governments. Recently many African countries have taken steps to attract FDI by improving their policy frameworks. Efforts include reforms aimed at increasing the role of the private sector in the economy, for example through privatisation. There are also steps taken to ensure and maintain macroeconomic stability, such as devaluation of overvalued currencies and the reduction of inflation rates and budget deficits. African countries are improving their regulatory frameworks for FDI - some 26 of the 32 least developed countries in Africa, surveyed by UNCTAD in 1997, have a liberal or relatively liberal regime for the repatriation of dividends and capital (UNCTAD, 1998). Progress is also being made with trade liberalisation, as well as the strengthening of the rule of law, and improvements in legal and other institutions that matter for the FDI climate. Finally, many African countries are establishing investment promotion agencies and have concluded bilateral investment and double taxation treaties that contribute to the creation of a more secure environment for foreign investors on the continent (UNCTAD, 1995). Though, as the statistics have shown, there has only been limited success in attracting FDI. Thus, it is clear that if African governments are to successfully formulate policies to attract FDI, it will require a clear understanding of why MNEs undertake FDI, and of the host country characteristics that draw FDI in. As yet, little work has been done on the determinants of FDI in Africa. Recent examples of the studies that do exist include the following. UNCTAD (1995) examines the principal economic determinants of FDI flows to Africa for the period 1991 to 1993. This study takes into account the level of development, market size, market growth and natural resource endowments as determinants of FDI. The conclusion is that in many African countries the full potential for FDI remains unexploited. The report does not however explain this further. McMillan (1995) provides a discussion of the determinants of FDI flows to Ghana and Cote d'lvoire, but no empirical analysis. Loods (2000) gives a broader overview of the trends and determinants of FDI flows to Africa, but also no empirical analysis. Chaudhuri and Srivastava (1999) offers an empirical investigation of the lack of private capital flows, which includes FDI, to sub-Saharan Africa, using a panel of thirty countries over the period 1986 to 1993. They find that total long-term private capital flows as a ratio of GDP is explained by factors determining the investment climate: that the impact of high and unsustainable budget deficits, low creditworthiness and high country risk on the investment climate in Africa has resulted in the dearth of private capital flows to the region. It is clear that a specific treatment of the determinants of FDI in Africa is required.


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3.3 THEORIES OF FDI There is no single theory of the internationalisation of production. One can however argue convincingly that MNEs undertake FDI in order to maximise profits. They spread their activities over different locations to enhance their competitiveness by capturing new markets and by acquiring new resources and skills. The determinants of FDI should thus be examined from the viewpoint of how they confer efficiency or cost advantages on the firms that undertake FDI. Dunning's (1993) theory of ownership, location and internalisation (OLI) advantages states that there are three conditions for a firm to become transnational and undertake FDI. The first is that the firm should possess net ownership advantages (intangible assets) that firms of other nationalities in the particular market do not have. This could be proprietary right to a product or a production process that the MNEs can exploit in foreign markets. Whatever its form, the ownership advantage confers market power or a cost advantage on the firm, that is sufficient to outweigh the disadvantages of doing business abroad. The second condition is that it must be of greater benefit to the firm possess these ownership advantages, to utilise them internally, than it is to rather sell or lease them to foreign firms. Thus the benefits of in-house transactions should exceed those of external markets. Finally, it must be profitable for the firm to employ those advantages with factor inputs outside its home country. These inputs can be natural resources in a host country or, for example, labour at low cost. A factor such as access to customers may also be important. Fulfilment of these three conditions may be seen as an explanation of the internationalisation of production and of why firms undertake FDI. It is important to note that the ownership and internalisation advantages are firm specific advantages whereby FDI yields efficiency gains or cost savings. The location advantages are country specific. Thus, in order to determine why FDI flows to some countries instead of others, the host country characteristics that allow foreign firms already possessing ownership advantages to maximise profits there, need to be examined. For this purpose, Wang and Swain (1997) classifies host country characteristics into micro-, macro- and strategic determinants of FDI. 3.3.1 Micro-determinants of FDI The micro-determinants of FDI are mainly concerned with those locationspecific factors that have an impact on the profitability of FDI at firm or industry level. Host country characteristics that influence productivity and cost at this micro-level include market size and growth, labour costs, host government policies and tariffs and trade barriers.

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3.3.2 Market Size and Growth FDI is likely to be attracted to host countries with large local markets and higher levels of economic development. A large, growing domestic economy ensures the TNC of a market for its product and provides for scale economies (Lucas, 1993). Transaction costs are also likely to be lower (McMillan, 1995). Evidence from empirical studies provides strong support for the importance of market size as a determinant of FDI. Wang and Swain (1997) surveys a number of early studies from the 1960s and 1970s and concludes that most studies come out in support of the size or growth of the markets in the host countries, as a significant determinant of FDI. In more recent work, Schneider and Frey (1985) and Wheeler and Mody (1992) also find market size to be related to FDI flows. 3.3.3 Labour Costs Labour costs are a clear consideration in a MNEs decision to employ its ownership advantages outside its home country. As wages rise, FDI aimed at low cost, efficient production, tends to be discouraged. Though, as wages rise relative to the cost of capital, there may be a tendency to substitute foreign capital in the place of labour (Lucas, 1993). Firms may also not only be interested in the lowest wages. MNEs may seek skilled labourers and professionals (Veugelers, 1991). Rather than just low wages, it is important that wages reflect productivity (Wang & Swain, 1997). MNEs aim to maximise profits through efficiency gains and/or cost minimisation. A related factor to take into account is that of labour disputes. A given host country is less attractive the greater is the incidence or severity of industrial disputes (Yang et al., 2000). The results of time series and cross-country analyses are also strongly in favour of relative low wages as a significant determinant of FDI flows. Specifically in the case of developing countries, Wheeler and Mody (1992) and Lucas (1993) finds a positive and significant relationship between lower labour costs and FDI inflows. Urata and Kawai (2000) ties this in with the nature of the MNE. They find that relative low wages are an important determinant of FDI by Japanese small and medium-sized enterprises (SMEs). The Japanese SMEs produce in neighbouring Asian countries in order to reduce their factor costs. Production is then exported back to Japan. In contrast, larger firms are more concerned with local sales and the size and growth of the host market.


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3.3.4 Host Government Policies Host government policies are location specific factors that may influence profitability and MNE's decision to undertake FDI, in a number of ways. Such policies include incentives and performance requirements (UN, 1995). Host governments often offer incentives to increase the attractiveness of their location. The incentives aim to encourage FDI inflows by reducing costs and making investment more profitable. Specific measures include tax breaks and trade incentives, like duty-free imports of inputs. The incentive schemes are often closely linked to efforts by the host government to encourage investment in export industries, or preferred sectors, or in less developed areas of the country. Most host countries believe that incentive schemes are crucial for attracting FDI, because competing economies have similar schemes. Related to incentives are performance requirements. A host government can place performance requirements on investors to try to ensure that the benefits of FDI accrue to the country. This takes the form of requirements concerning the hiring and training of local personnel, local content, technology transfer and exporting of output. Where incentive schemes may attract FDI, the interference of government performance requirements may deter it. To negate this possible negative effect governments often link meeting the requirements to fiscal incentives like tax rebates. The empirical literature, however, finds the impact of government policies to be less straightforward. Helleiner (1989) finds that specific incentives do not have a major impact on FDI flows. Incentives influence the decisions of investors only at the margin. Dees (1998) adds to this, citing a survey according to which investment incentives are only moderately significant for the decision of US firms to invest in China. The evidence does show that removing restrictions and providing good business operating conditions will affect FDI flows positively. 3.3.5 Tariff and Trade Barriers The so-called "tariff hopping" hypothesis states that high protective trade barriers make exports by MNEs to a potential host country, uncompetitive. Potential marketing cost savings, from avoiding protectionist barriers, as well as transport cost reductions, encourage MNEs to rather enter the market through FDI and to serve their customers with local facilities (Wang & Swain, 1997). A growing internal market will add to the attractiveness of tariff hopping. Jun and Singh (1996) tests the tariff hopping hypothesis and finds the relationship between taxes on international trade and transactions, and FDI, to

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be positive and significant. Yung et al. (2000) supports this result but with a different method. Measuring the openness of the Australian economy as the sum of exports and imports as percentage of GDP, they find a negative relationship with FDI. They subsequently argue that FDI inflows substitute for trade, much like the case made in the tariff-hopping hypothesis. It should be noted that the influence of these location-specific microdeterminants of FDI depends on a number of factors. Firstly, the nature of the investment is important. If the investment is for export production, the expected return from a particular site will depend more heavily upon unit input costs. If the investment is intended to serve the local market, then the size and openness of the market will be of significance. The stage of the product's life cycle, as between a new, mature or standardised commodity may also be of significance. Locations with lower input costs are important when the product is standardised. One or a combination of these factors may tip the balance and encourage a firm to locate production facilities in a particular country.

3.4 MACRO-DETERMINANTS OF FDI The macro-determinants of FDI are the factors that influence profitability and the choice to invest at an economy-wide level. These are the size and growth of the host market and factor prices. Factor prices are in turn influenced by tariffs and taxes. Thus there is much of an overlap with the micro-determinants of FDI, though the emphasis here is on the influence that the general macroeconomic environment has on FDIflows.The effects of the macro-environment are also reflected in a number of additional determinants of FDI. These include openness and export orientation, exchange rates, the inflation rate, budget deficit, domestic investment as well as political risk. 3.4.1 Openness and Exports There are number of arguments linking openness, and exports, and FDI flows. The tariff-hopping hypothesis described in the previous section posits that there is a negative relationship between openness and FDI. Closed economies receive FDI, which is substituting trade. The opposing view is that outwardorientated economies are more successful at attracting FDI. The pressure of international competition makes for higher productivity. An outward-orientated economy is also not handicapped by the size of its domestic economy when attracting FDI - it offers efficiency and access to world markets. Empirical studies of whether a host country's export orientation may be important for attracting FDIflowsfindin favour of openness. Lucas (1993) finds that in Southeast Asian countries FDI is more elastic with respect to the demand for exports, than with respect to the aggregate domestic demand. Jun


57

and Singh (1996) states that exports should be included as a control variable because of the higher export propensity of foreign affiliates. They find a particularly strong relationship between exports in general, and manufacturing exports in particular, and FDI. One should however note that the empirical literature raises a causation question - whether FDI flows are attracted to economies that are export orientated or whether FDI leads to increases in exports. Jun and Singh (1996) argues that the relationship is likely to be simultaneous, with current results supporting the general notion that exports precede FDI. 3.4.2 Exchange Rates Related to openness is the importance of exchange rates as a determinant of FDI flows to host economies. There are broadly two lines of thought concerned with the significance of exchange rates as a determinant of FDI: the currency area hypothesis and considerations of exchange rate risk. The currency area hypothesis argues that firms from harder currency areas are able to borrow at lower costs, and to capitalise the earnings on their FDI in softer currency areas at higher rates, than the local firms. The higher the share of capital value added and the size of the premium on the local currency, the greater the comparative advantage which foreign investors enjoy over local firms and that attracts FDI. The second line of argumentation takes account of the exchange rate risk to which MNEs are exposed when undertaking FDI and how that influences the decision to locate in a particular country. The nature of the risk firstly depends on the MNEs' activities in the host country. If the MNEs produce for export, depreciation is beneficial, making output more competitively priced. However, if a substantial portion of inputs is imported, depreciation raises costs. Even when the nature of TNC activity is not taken into account, the exchange rate may be important. Large fluctuations in the rate discourage FDI flows, as it increases uncertainty associated with the economic environment of the host country (Urata & Kawai, 2000). The exchange rate also determines the value of repatriated profits. In developing countries a deteriorating exchange rate and foreign exchange position may further threaten restrictions on such remittances, irrespective of what exchange controls are normally in place (Lucas, 1993). Empirical evidence on the significance of the exchange rate as a determinant of FDI is indeterminate. Studies of the effect of exchange rate devaluation on FDI shows that it depends on whether MNEs in a country are dependent on the foreign market relatively more for the export of their outputs, or for the import of their inputs (Wang & Swain, 1997).

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3.4.3 Inflation Rates Where the exchange rate reflects external economic balance or imbalance, the inflation rate is an indicator of a country's internal macroeconomic stability. Increased instability adds to uncertainty and makes investment unattractive. A high rate of inflation is a sign of internal economic tension and the inability or unwillingness of the government and the central bank to balance the budget and to restrict money supply (Schneider & Prey, 1985). This increases uncertainty regarding the business environment. Inflation also increases the cost of production (Urata & Kawai, 2000). Consequently it has a negative impact on FDI flows. Empirically this is confirmed by Schneider and Prey (1985), Yung et al. (2000) as well as Urata and Kawai (2000). 3.4.4 Budget Deficits The budget deficit is similarly related to uncertainty and the choice to invest. A high or increasing budget deficit is not a host country characteristic that encourages FDIflows.It is more likely to cause uncertainty regarding the sustainability of the host government's fiscal stance and about what that may imply for the cost and profitability of investment. Empirical work by Chaudhuri and Srivastava (1999) supports a negative and significant relationship between budget deficits and FDI flows. 3.4.5 Investment and Infrastructure FDI supplements domestic capital but it may be argued that the causation also runs the other way: domestic investment crowds in FDI. It does so by increasing productive capacity (Chaudhuri & Srivastava, 1999). In the same way infrastructure creates an enabling environment for foreign investors. It increases productivity and reduces the cost of production, which draws in FDI. Empirical results from Wheeler and Mody (1992), Cheng and Kwan (2000) as well as Urata and Kawai (2000) confirm this relationship. 3.4.6 Political Instability Political instability embodies a variety of concerns, ranging from production disruption to confiscation or damage to property, to threats to personnel, to a change in macroeconomic management or the regulatory environment (Lucas, 1993). Political instability is expected to decrease FDI because it increases uncertainty about the cost and profitability of investment. McMillan (1995) notes that stability may not however have the opposite positive effects. It adds to a general feeling of investment security, but does not have the specific "pull" as strong as that created by market forces.


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Empirical studies produce mixed results. Wang and Swain (1997) finds that evidence from surveys of MNEs and their executives support a negative correlation between FDI flows and political instability. Evidence from cross-section studies, on the other hand, shows that political variables are of minimum concern to investors and are generally given the same treatment in FDI decisions as in domestic investment decisions. Wheeler and Mody (1992) uses a broad component measure of administrative efficiency and political risk. This includes measures of the likelihood and nature of a government change, the attitude of opposition groups to FDI, the likely degree of labour disruptions, the local terrorism risk factor, the difficulty in obtaining approvals and permits from bureaucrats, bribes required, as well as the efficiency and integrity of the legal system. They find the aggregated measure to be statistically insignificant. As an alternative to the composite indicator approach to measuring socio-political risk, Lucas (1993) uses episodic dummies for "good events" and "negative events" in East and Southeast Asian countries. "Good events", such as the Asian and Olympic games in the Republic of Korea, or President Aquino's accession in the Philippines, are found to be positively related to FDI. "Negative events", such as Park's assassination in the Republic of Korea, or Ferdinand Marcos' martial law in the Philippines, are found to be negatively related to FDI. Jun and Singh (1996) attributes the conflict between the results of the various studies to the difficulty in obtaining reliable quantitative estimates of a qualitative phenomenon, for an extended period of time. Wang and Swain (1997) add that the definition of political instability is particularly problematic. Econometric studies of the determinants of FDI may focus on events characterising political instability when they should be concerned with the potential manifestation of those events as constraints upon foreign investors. Political instability does not always enhance political risk to FDI.

3.5 STRATEGIC DETERMINANTS OF FDI The strategic determinants of FDI refer to long-term factors influencing the decision to invest in a country. MNE strategy determines FDI when it is undertaken to defend existing foreign markets, or to diversify a firm's activities. The strategy may also be to gain/maintain a foothold in a protected market, to gain/maintain a source of supply through FDI, or to gain advantage in complementing another type of investment. When considering the strategic determinants of FDI, there is less that a host country can do to attract FDI - this is more about the characteristics of the MNE. Although this discussion has shed some light on the host country characteristics that draw in FDI, it is clear that the literature on the determinants of FDI is wide ranging. Alongside there exists a wealth of empirical studies ex-

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amining the significance of these determinants. The tentative conclusion may be that larger, open, more stable economies are more likely to attract FDI flows. There is however little proof of the significance of these determinants of FDI in Africa. Section 4 estimates a model of the determinants of FDI for 17 countries in sub-Saharan Africa.

3.6 EMPIRICAL ANALYSIS Empirical studies of the determinants of FDI can be based on three approaches: micro-orientated econometric studies, survey data analyses and aggregate econometric analyses. The analysis here uses an aggregate econometric approach at the country level, discerning only some of the macroeconomic determinants of FDI. 3.6.1 The FDI Econometric Model Following Jun and Singh (1996), a simple stock-adjustment model is used to describe the determinants of FDI. The single equation model: FDI? = A + B(CVt) + Et

(3.1)

states that the desired FDI stock at time t{FDlf) is determined by a vector of control variables (CVj), discussed below, and a random error term Et. The speed of adjustment is incorporated into the model as shown in the following equation: FDIt - FDIt-i = Z(FDI? - FDh-i).

(3.2)

Equation (3.2) shows that changes in actual FDI will respond only partially to the difference between the desired FDI and the past values of that investment. In any given period, a desired level of FDI may not be realised fully (as actual FDI in the subsequent period), because of physical and procedural constraints. The parameter Z captures the speed of adjustment to the desired level of FDI. By substituting FDlf from equation (3.1) into equation (3.2) and rearranging, equation (3.3) is obtained: FDIt = ZA + BZ(CVt) + (1 - Z)FDIt-i + ZEt

(3.3)

Thus, FDIflowsat time t is a function of a vector of control variables, FDI flows in the previous period and a random error term. Each of the explanatory variables takes the speed of adjustment to the desired level of FDI into account. In addition to the rationale given in a simple stock adjustment model,


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using the lagged dependent variable as an explanatory variable also takes care of any residual autocorrelation that might exist. It incorporates indirectly other omitted factors that may have influenced FDI in the previous period (Jun & Singh, 1996). Using the previous empirical studies, reviewed in chapter 2, as a guide to the variables to include, the fully specified model is defined as follows: RFDI = A + Bi{RFDIl) + B2{GDPCAP) + B- 3(GDPGROW)+ B4 {GDI) + B5 (OPEN) + B6 (INF) + B7 (OVR) + (3.4) B8(SECSCHOOL) + B9(PHONE) + Et

The dependent variable (RFDI) is FDI inflows in constant dollars as a ratio of GDP. Several control variables are included in the model: past FDI flows, market size and growth and domestic investment. There are also measures of the openness of the economy, internal and external stability, the quality of labour, as well as infrastructure. The specification of the variables and hypotheses of the coefficients are as follows. •

Past FDI flows

FDIflowsare likely to require time to adjust to their desired levels, depending on the specific constraints facing MNEs. Including past FDI flows (RFDI1) serves to show the partial adjustment process incorporating the speed of adjustment of actual levels, to desired levels of FDI flows (Jun & Singh, 1996). It may also serve as a crude measure of agglomeration effects. Agglomeration effects exist when the localisation of industry generates positive externalities - and past FDI attracts more FDI (Cheng & Kwan, 2000). •

Market size and growth

FDI has been argued to be attracted to host countries with large local markets. Previous empirical evidence has shown market size to be one of the most important determinants of FDI. For equation (3.4), the size of the market (GDPCAP) is measured by real GDP per capita in constant dollars (international prices, base year 1985). The data is obtained from the Penn World Tables 5.6. The higher GDP per capita, the better are the prospects that FDI will be profitable. Also, market growth is an indicator of a good development potential in the future. The growth of the market (GDPGROW) is measured by GDP per capita growth (annual percentage) and again a positive influence on FDI is expected. Jun and Singh (1995) notes that when the dependent variable is FDI relative to GDP, the relationship of FDI with other GDP related variables on the right hand side of equation (3.4) may not be unequivocal. Hence, both per capita GDP and the growth rate of per capita GDP are included to control for actual and potential market size.

62

W. KRUGELL

•

Domestic investment

Domestic investment improves a country's productive capacity and may crowd-in FDI. The GDI-variable represents gross domestic investment as a percentage of GDP, as measured in the World Development Indicators. A positive relationship with FDI is expected. •

Openness

The survey of the theoretical and empirical literature in section 3 has shown that there are divergent views on the relationship between the openness of the economy and FDI flows. Tests of the significance of openness as a determinant of FDI in African countries encounter data problems. Statistics of taxes on international trade and transactions are incomplete or not available for the countries in the study. This precludes a direct test of the "tariff hopping" hypothesis. To evaluate the arguments in favour of an outward orientation, this study includes the OP.E'./V-variable, which represents total trade as a percentage of GDP. Total trade is imports plus exports. This is similar to the measure used by Yang et al. (2000) and the aim is to capture the total effects of the host country's exposure to the outside world. The data is from the World Development Indicators. The effect of openness on FDI is uncertain. •

Inflation

Inflation is used as a measure of internal economic stability. A high rate of inflation reflects macroeconomic instability, which adds to uncertainty and makes investment unattractive. Inflation (INF) in this study is inflation of consumer prices (annual percentage), with the data coming from the World Development Indicators. A negative relationship with FDI is expected. •

Overvaluation

The real overvaluation of the domestic currency is used as a measure of external economic stability. Overvaluation of a currency indicates that macroeconomic policies may be unsustainable, which increases uncertainty (Agarwal, 1980). The OVR-variable represents a real effective exchange rate index from Dollar (1992) and the World Development Indicators. A negative relationship with FDI is expected. •

Quality of labour

Skilled labour is hypothesised to be more productive and to attract FDI. Secondary school enrolment (percentage gross) is used as a rough measure of the quality of labour (SECSCHOOL). The data is again from the World Development Indicators.


63

Data availability precludes further analysis of hypotheses concerning labour. This is unfortunate considering the importance of low-cost labour as a determinant of FDI flows in studies of other regions. Data on industrial disputes and strikes in African countries are also only available for the last few years and have many gaps. •

Infrastructure

Infrastructure provides an enabling environment for the foreign investor and increases a country's productive capacity. This is proxied by the PHONEvariable, which is the number of telephone mainlines per thousand people. A positive relationship with FDI is expected. The model is estimated using panel data estimation techniques. The analysis covers the period 1980-1999 for 17 countries in sub-Saharan Africa. The choice of countries is based on the availability of consistent data. The 17 countries in the basic specification are: Benin, Burkina Faso, Burundi, Central African Republic, Democratic Republic of the Congo, Gambia, Lesotho, Malawi, Mauritius, Niger, Nigeria, Rwanda, Senegal, Seychelles, South Africa, Uganda, and Zimbabwe. For the estimation of a pooled cross-country and time series model, the interpretation of the relationship between FDI and the explanatory variables, as they are modelled in equation (3.4), needs to be extended. In panel data, two different types of models can describe the relationship, namely the fixed effects model and the random effects model (Chaudhuri & Srivastava, 1999). In the fixed effects model, RFDIjt gives the value of FDI flows (RFDI) for a specific country (the jth unit) in a particular period (time t). RFDIjt depends on M exogenous (control) variables, as they are set out in equation (3.4). The values of the exogenous variables differ among countries in the cross section at a given point in time and also exhibit variation through time. RFDIjt also depends on variables that are specific to a particular country and that stay constant over time. The model can be expressed as: RFDIjt = OLJ + P\CVjt) + et

(3.5)

where j = the 17 countries mentioned above and t = 1980, . . . ,1999. Here (3 is an M x 1 vector. The at is a scalar constant representing the impact of variables that are specific to a country and remain constant over time. The random error term et shows the effects of these omitted variables that are specific to both countries and time periods. This is also known as the Leastsquares dummy variable model. The estimator is ordinary least squares.

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W. KRUGELL

The random effects model is specified in a similar fashion, but country specific effects (the a, s ) are treated as random variables. The model can be written as:

RFDIjt = f3\CVjt) + Ht

(3.6)

The fijt now presents a combined error term consisting of a.j and Sjt. The errors are assumed to have a zero mean, to be uncorrelated and homoscedastic. The model is also known as the variance components model and it is estimated with the generalised least squares estimator. The choice between fixed and random effects can be a difficult one. In this case the random effects model is estimated, following the motivations of Wheeler and Mody (1992). Since the aim is to examine the relationship between FDI flows and host country characteristics, much of the interesting variation in the data is across countries, reflecting conditions that change only slowly (for example market size). The use of country specific dummies (fixed effects) would have the result of removing this variation, leaving only short-run, withincountry changes as the basis for parameter estimation. The results would tell much less about the host country characteristics that attract FDI. The fully specified model, that is estimated as a random effects model, can be restated as follows:

RFDIjt = aj + ^(RFDIljt) + f32(GDPCAPjt)+ fo(GDPGROWjt) + fa{GDIjt)+ (35(OPENjt) + lh(INFjt) + (37{OVRjt)+ fo{SEC'SCHOOL jt) + /39{PHONEjt) + et

3.7 RESULTS AND INTERPRETATION A number of different specifications of the model are estimated. In the very basic specification past FDI flows, GDP per capita, GDP growth and gross domestic investment explain FDI. The other variables are added progressively to the model. Note that all the variables are ran with a one-period lag. The results of four of the estimated models are reported in Table 3.1. Model 1 is the basic model relating FDI flows to past FDI flows, GDP per capita, GDP per capita growth, domestic investment and openness. The results show the expected signs on all the coefficients with the exception of that of GDPCAP. GDP per capita is found to be negatively related to FDI flows with a small and insignificant coefficient. Past FDI flows and gross domestic investment are found to be positively and significantly related to current FDI flows at the 5 per cent level.

65


In model 2 the effect of inflation is added. The /./VF-coefncient has the expected negative sign, but the coefficient is small and statistically insignificant. Adding the variable for inflation also causes GDI to no longer be statistically significant and it reverses the sign on GDPGROW. GDP per capita growth is now found to be negatively related to FDIflows,though the coefficient is small and insignificant. The coefficient on past FDIflowsis still positive and significant. Openness is positively and significantly related to FDIflowsat the 10 per cent level.

Dependent Variable

Model 1

Model 2

Model 3

Model 4

RFDI

RFDI

RFDI

RFDI

Constant

0. 154 (4. 221)*

0. 142 (2. 238)

0.074 (2. 775)

0. 145 (7. 003)

RFDI 1

0.376 (7. 050)*

0.472 (5. 870)*

0.784 (18. 986)*

GDPCAP

-0. 0002 (-0. 373)

-0. 0003 (-0. 478)

GDPGROW

0.010 (0. 522)

-0. 004 (-0. 131)

-0. 0003 (-1. 269) 0.035 (1. 949)*

-0. 108 (-1. 138) 0.007 (5. 685)*

GDI

0.094 (2. 608)* 0.005 (0. 330)*

0.064 (1.032)

0.093 (1. 899)*

0.050 (1.946)**

0.023 (1. 649)** -0. 015 (-1.427)**

OPEN

-0. 007 (-0. 544)

INF

0.008 (0. 460) 0.007 (0. 199) 0.061 (5.611)* -0. 023 (-2. 979)*

0.014 (1. 189)

OVR

0.295 (0.371)

PHO Adjusted R2

0.46

0.81

0.84

0.53

F

39.5

114.4

101.5

18.9

D.W.

2.424

2. 172

2.906

1.752

238

168

143

108

Number of Observations Note: t - statistics are given in ]larenthesis * denotes at 5 % level ** denotes at 10% level

Table 3.1. Empirical Results

In model 3 overvaluation of the domestic currency also enters as an explanatory variable. It has an unexpected positive sign and is statistically insignif-

66

W. KRUGELL

icant. This however seems to be the best specified model. It explains 84 per cent of the variation in FDI flows and finds most of the determinants to be significant, with the expected signs. Past FDI flows are a positive and significant determinant of current FDI flows. GDP per capita growth is again positively and significantly related to FDI. Investment and openness are found to be positive and significant and inflation negative and significant at the 10 per cent level. Model 4 adds the infrastructure variable. This makes for some contradictory results. Note that this model is estimated for a much smaller number of countries (only 9) and has to exclude the overvaluation variable since the estimation procedure requires that there be more cross-sections (greater number of countries) than there are variables to be estimated. The number of phone lines per 1000 people has the expected positive relationship with FDI flows, but the coefficient is statistically insignificant. The inclusion of PHO however causes past FDI flows to be negatively, though insignificantly, related to current FDI flows. Both GDP per capita and GDP per capita growth now have the expected positive relations to FDI. Though the coefficient is small, GDPCAP is now even statistically significant. The openness and inflation variables have their expected signs and are statistically significant at the 5 % level. In addition to the models reported on, a number of less successful specifications were also attempted. The SEC SCHOOL measure of the quality of labour was used in a regression of FDI flows on past flows, market size and growth, and investment. This was again for a smaller number of countries. The results show SECSCHOOL to have a negative and insignificant relationship to FDI. It was also attempted to use the lengths of roads, instead of the number of phone lines, as a measure of infrastructure. The data, however, shows very little variation and thus has limited explanatory power. Finally, it was attempted to include a measure of political risk. This was unsuccessful due to data problems. The first constraint is that there is no time series data available for the period. The typical measures of political risk are only assessed intermittently. The alternative is to then use indices from the international country risk guide to define dummy variables indicating bureaucratic quality, corruption and the risk of expropriation. This is a crude measure at best and it suffers from the additional problem that it is not available for a number of the countries in the sample. When added to the models above, the regression can be done only for four countries, which leaves little room for adding the explanatory variables. In the end these less successful attempts were abandoned. Thus, the results confirm some of the conventional wisdom of the determinants of FDI and provide for a few surprises. Firstly, past FDI seem to be the most important determinant of current FDI flows to the countries. The coefficient is large, positive and highly significant in most specifications of the


67

model. Without industry level data it may be presumptuous to infer that these are agglomeration effects. It may be more likely that when FDI is already taking place in a country, MNEs see that as a signal that it is a save and suitable country to invest in and more FDI follows (Urata & Kawai, 2000). Secondly, Africa's small and under-developed economies do not attract FDI on the basis of their market size. In the main specifications GDP per capita is negatively related to FDI. The growth of the market may remedy this, as the models largely found a positive relationship between GDP per capita growth and FDI. The results further show that foreign investors prefer an environment conducive to their activities. That is an environment with low inflation and thus less uncertainty. Domestic investment attracts FDI by increasing the productive capacity of the economy. There is some evidence in favour of greater outward orientation as a determinant of FDI. To some extent, however, this maybe drawn into question by the unexpected positive relationship found between overvaluation of the exchange rate and FDI flows. Though the coefficient is small and insignificant it is a cause of concern. A possible explanation may be that the overvaluation of the exchange rate reflects the more restrictive trade regime found in African countries. Overvaluation may be positively related to FDI to the extent that the FDI is "hopping" the barriers that cause the overvaluation. This, unfortunately, contradicts the results on the OPEN-variable. It may also be taken to indicate that FDI in these African countries are more market-seeking than efficiency-seeking. That is again difficult to reconcile with the negative relationship found between market size and FDI flows. It is clear that further investigation is needed.

3.8 CONCLUSIONS Conclusions and recommendations should be made with care. The analysis may be faulted on its very nature. Firstly, the nature of the determinants is such that they do not change much over short periods of time. Hence change in such variables is not likely to be very successful in explaining changes in FDI over time (UN, 1995). Secondly, the analysis pools data for a group of countries that may be structurally diverse. Structural differences refer to significant discrepancies in the basic macroeconomic variables that characterise an economy. Aggregate analysis may conceal as much as it reveals (Jun & Singh, 1996). Thus, it is problematic to apply a broad brush of recommendations.

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W. KRUGELL

The recommendation that can be made is that African countries should focus their efforts on staying the course of what is today regarded as prudent governance. A stable macroeconomic environment may be important for attracting FDI flows and it is important for growth and development prospects in general. In the same way, domestic investment enhances a country's productive capacity and it may crowd-in FDI flows by creating an enabling environment for the activities of foreign investors. Although the results on the importance of the openness of the economy for attracting FDI were mixed, the state of the art currently favours open, outward-orientated economies for growth. Future African growth and development prospects will not be enhanced in closed economies. Although this chapter has been able to analyse some of the economic determinants of FDI in Africa, a number of questions are unanswered and allow for recommendations for further analysis. Firstly, extensions of the study should attempt to address some of the data problems mentioned in section 4. Indicators of wage costs and political risk would be valuable. A possible extension indicated by the growth accounting literature for Africa, would be to examine geography and natural resources as determinants of FDI. However, finding data on transport costs or resource exports may again be problematic. Finally, it can be said that it should be kept in mind that the determinants of FDI depend on many factors - not least of these the nature of FDI itself. As African countries shape their policies to attract FDI, they should also consider the type of FDI they wish to attract. The discussion in section 3 showed that some MNEs are market seeking and others are efficiency seeking and export orientated (Cheng & Kwan, 2000, Resmini, 2000). Thus there are different determinants of the different types of FDI to take into account.

REFERENCES ADR, see AFRICAN DEVELOPMENT REPORT. African Development Report, (2000). Regional integration in Africa. New York: Oxford University Press. Agarwal, J. P. (1980). Determinants of foreign direct investment: A survey, Weltwirtschaftliches Archiv, 116, pp. 739-773. Anon. (2001). Africa's elusive dawn. The Economist, Feb. 24. Chaudhuri, K., Srivastava, D. K. (1999). Dearth of private capital flows in sub-Saharan Africa, Applied Economics Letters, 6, pp. 365-368.


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Cheng, L. K., Kwan, Y. K. (2000). What are the determinants of the location of foreign direct investment? The Chinese experience, Journal of International Economics, 51, pp. 379-400. Dees, S. (1998). Foreign direct investment in China: Determinants and effects. Economics of Planning, 31, pp. 175-194. De Mello, L. R. (1999). Foreign direct investment-led growth: Evidence from time series and panel data. Oxford Economic Papers, 51, pp. 133-151. Dollar, D. (1992). Outward-orientated developing countries really do grow more rapidly: Evidence from 95 LDCs, 1976-1985, Economic Development and Cultural Change, 40, pp. 523-544. Dunning, J. H. (1993). Multinational enterprises and the global economy. Workingham: Addison-Wesley. Easterly, W., Sewadeh, M. (2001). Global development network growth database. [Available on the internet:] http://www.worldbank.org/research/growth/GDNdata.htm. Hawkins, P., Lockwood, K. (2001). A strategy for attracting foreign direct investment. (Paper delivered on 13 September 2001 at the conference of the Economic Society of South Africa.) Glenburn Lodge, Johannesburg. (Unpublished). Helleiner, G. K. (1989). Transnational corporations and direct foreign investment. (In: Chenery, H. and Sriniv, T.N. eds. Handbook of Development Economics. Vol. 2. Oxford: North-Holland, pp. 1441-1480.) Jun, K. W., Singh, H. (1996). The determinants of foreign direct investment in developing countries. Transnational Corporations, 5. pp.67-105. Loods, E. (2000). Foreign direct investment flows to African countries: Trends, determinants and future prospects. Mots Pluriels, 13. [Available on the internet:] http://www.arts.uwa.au/MotsPluriels/MP13000el.htm. Lucas, R. E. (1993). On the determinants of foreign direct investment: Evidence from east and south-east Asia. World Development, 21, pp.391-406. McMillan, S. (1995). Foreign direct investment in Ghana and Cote d'lvoire. (In: Chan, S. ed., Foreign direct investment in a changing global political economy. New York: St. Martin's Press, p.150-165.)

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Resmini, L. (2000). The determinants of foreign direct investment in the CEECs: New evidence from sectoral patterns. Economics of Transition, 8, pp.665-689. Schneider, F., FREY, B.S. (1985). Economic and political determinants of foreign direct investment. World Development, 13, pp.161-175. Stoker, H. (2000). Growth effects of foreign direct investment - myth of reality? (In: Chen, J. ed. Foreign direct investment. Houndsmills: MacMillan, pp.115-137.) UNCTAD see United Nations Conference on Trade and Development. (UN) United Nations. (1995). Sectoral flows of foreign direct investment in Asia and the Pacific. ESCAP studies in trade and development. No. 5. New York: United nations, p.17-25. United Nations Conference on Trade and Development. (1995). Foreign direct investment in Africa. Division on transnational corporations and investment. Current studies, Series A, No. 28, New York: United Nations. United Nations Conference on Trade and Development. (1998). Foreign direct investment in Africa: Performance and potential. New York: United Nations. Urata, S., Kawai, H. (2000). The determinants of the location of foreign direct investment by Japanese small and medium-sized enterprises. Small Business Economics, 15, pp.79-103. Veugelers, R. (1991). Locational determinants and the ranking of host countries: An empirical assessment. Kyklos, 44, pp.363-382. Wang, Z. Q., Swain, N. (1997). Determinants of inflow of foreign direct investment in Hungary and China: Time-series approach. Journal of International Development, 9, pp. 695-726. Wheeler, D., Mody, A. (1992). International investment location decisions: The case of US firms. Journal of International Economics, 33, pp. 57-76. WIR see World Investment Report. World Bank. (1999). World development indicators. Washington D.C.: World Bank. World Investment Report. (2000). Cross-border mergers and acquisitions and development. New York: United Nations.


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Yang, J. Y. Y., Groenewold, N., Tcha, M. (2000). The determinants of foreign direct investment in Australia. Economic Record, 76, pp. 45-54.

THE GLOBAL INTEGRATION OF AFRICA: The EU-SA Free Trade Agreement and German MNEs in South Africa W. NAUDE, 1 W. KRUGELL 2 and N. BAUER 3 1 2 3

North-West University, South Africa North-West University, South Africa University of Paderborn, Germany

4.1 INTRODUCTION4 According to the United Nation's Human Development Index (HDI), 18 of the 20 least developed countries in the world are in Africa. Africa's unsatisfactory economic development experience has in recent years come increasingly under scrutiny. The so-called African development "tragedy" is reflected in persistent poverty, low growth and high inequality. During the 1980s, the average growth in GDP per capita in Sub-Saharan Africa (SSA) was -1.3%. Current estimates put per capita income in Africa (in P P P terms) at roughly US$ 1045 - more than 10 times lower than that in the average OECD country. The result of low growth and low per capita incomes is that more than 40% of the African population may be living below the accepted poverty line of US$ 1 per day. Taking into account measurement methods, Africa also has the most unequal distribution of income in the world - exceeding that of Latin America. On a political level, calls have increasingly been made for Africa to reverse this process of economic underdevelopment through "African unity". Calls for and discussions about an "African Century", "The African Renaissance", a "United States of Africa" has all been prominent in recent times. Of course, calls for African unity is nothing new - the Abuja Treaty of 1948 having already called for an African Economic Union by the year 2000. This chapter critically assesses, from an economic point of view, the potential of regional economic integration amongst African countries for promoting 4

An earlier version of this paper was presented at a Graduate Seminar, Faculty of Economic Sciences, Universitat-Gesamthochschule Paderborn, January 2000. The authors wish to thank the many participants, in particular Professor Mike Gilroy, for their useful comments.

74

W. NAUDE, W. KRUGELL and N. BAUER

economic development in Africa. It does so by considering the recent explanations for Africa's poor economic development and by assessing the African experience with regional integration. The insights from these analyses are then combined with recent theoretical advances in understanding the extent to which economic integration schemes leads to divergence or convergence of per capita incomes amongst members states. The chapter concludes, with reference to the recent Free Trade Agreement between South Africa and the EU, that integration amongst African states may be sub-optimal to integration between African states and a higher income region (e.g. the EU) and that regional cooperation in terms of economic policy and political stability may be vital in the face of significant neighbourhood effects on economic growth. Seen in this way, the contribution of this chapter is to call on African states to focus on economic integration with countries outside of Africa for expansion of trade and for obtaining technology and investment. In this, the paper sounds a positive note on the advantages of globalisation for African economic development. African countries should furthermore not expect of economic integration agreements amongst themselves to lead necessarily to greater trade. The advantage of regional integration amongst African countries lies rather in its potential to enhance economic policy co-ordination and the adoption of sound macro-economic policies and governance practices. The economic development case for regional integration between Euroland and Southern Africa can thus be made. The chapter is structured as follows. In section two it is showed that there is a great consensus that a major cause of Africa's disappointing economic performance is that fact that African economies are amongst the most closed economies in the world to international trade. It is argued that regional integration is called for as a way to ensure trade liberalisation but on a limited scale. In section three Africa's experience with regional integration in the past is seen not had been successful, and that it had contributed little to intraregional trade in Africa. In fact the argument that regional integration can assist to enlarge the markets for African products is shown to be false, as most African countries have similar revealed comparative advantages and trade in the same basic commodities. In section four some new contributions to the theory of regional integration are set out. These contributions can be applied to the African situation to argue that regional integration may present Africa with a lose-lose situation and that integration between African economies and a higher-income economy may be preferential. Section five concludes.

4.2 AFRICA'S ECONOMIC CRISIS The economic crisis in Africa has led scientist and policy makers to use a number of approaches to gather evidence as to the causes of the crisis. These ap-

4 THE GLOBAL INTEGRATION OF AFRICA

75

proaches included us of cross-country growth regressions, case studies as well as micro-economic survey evidence on households, markets, firms, labourers and investors. Micro-economic longitudinal surveys have been conducted with increasing regularity in African countries since the early 1990s. These include household surveys and so-called Living Standard Measurement Surveys that have indicated that macro-economic reforms and greater openness of African economies can lead to improvements in living standards (World Bank, 2002). They also include the World Bank's Regional Programme on Enterprise Development (RPED) that surveyed firms in eight African countries. These surveys supported recent policy implications of the endogenous growth literature 5 but also supported the macro-economic evidence of the cross-country regressions as far as suggesting the importance of lowering the riskiness of the African environment and of opening up African economies to foreign trade. Cross-country growth regressions have been popular in economics since the revival of growth theory and the rise of the so-called endogenous growth theory, see for instance Barro (1991) and Sala-I-Martin (1997). In these regressions, which are typically run using some adaptation of the Solow-model, the dummy variable for "Africa" as a region was initially consistently significant. A number of authors (e.g. Easterly and Levine, 1997) expanded the set of variables in order to account for this "African dummy". They found that six broad sets of variables were significant in explaining the African dummy, namely •

The lack of social capital in African communities coupled with high levels of ethnic diversity;

•

The lack of openness to trade;

•

Deficient public services;

•

Africa's geography and high riskiness of investment in Africa;

•

The lack of financial depth of African economies;

•

Africa's high aid dependence;

From the perspective of regional integration, many calls for regional integration amongst African countries in recent years have been motivated by the finding that African economies need to be more open to international trade. 5 These are that four broad avenues of policies could raise economic growth, namely policies that ensures (a) learning by doing (Romer,1986), (b) human capital formation (Lucas, 1988), (c) research and development (Aghion and Howitt, 1992) and (d) public infrastructure investment (Barro, 1990).

76


Thus, regional integration is seen as a reciprocal way of lower trade barriers, but without subjecting previously sheltered industries to the full force of international competition. Although it will be argued that this policy prescription is wrong, the diagnosis is correct and there is now a significant consensus that one of the most serious causes of Africa's slow growth has been its lack of openness to trade. As noted by Jenkins and Thomas (1999) with reference to the cross-country regressions "Almost all of these concerned exclusively with Africa find that impediments to trade have been detrimental to growth performance, reducing the annual growth rate by between 0.4 and 1.2 percentage points". In the regressions of Sachs and Warner (1995) openness to international trade is based on a composite indicator consisting of the size of tariffs, the extent of non-tariff barriers, the difference between the black market and official exchange rates, the type of economic system, and the extent of state control over major exports. Sachs and Warner (1995) find that most of the countries in Africa were effectively closed to international trade for the 25 years from 1965 to 1990. Only Botswana and Mauritius were "open" for any length of time. The lack of openness was especially negative as far as it contributed to the failure of manufacturing in Africa. This is firstly because closed economies meant that the input prices of capital and intermediate inputs were above world market prices. Secondly, the closed domestic markets were small, preventing scope for either economies of scale or domestic competition. As a result, African manufacturing firms remained inefficient, which in turn caused reduced investment and skills formation (Jenkins and Thomas, 1999). The overall impact of this vicious cycle is the low growth rates in Africa and the inability of African countries' per capita incomes to convergence to levels of other countries. Ng and Yeats (1999) found that in Africa, countries that adopted less restrictive governance and trade policies were in fact able to achieve significantly higher levels of per capita GDP as well as higher growth rates for exports. Many countries have embarked on regional integration as a "reciprocal" manner to liberalise trade - as opposed to unilateral trade liberalisation. In this light, it can be understood that from an economic point of view, calls for African regional integration in 2000 are different from the calls that were made for African regional integration in the years immediately after independence. Then, the calls were made based on arguments for larger markets, as well as political arguments. Today the calls are made to ensure the opening up of African economies (Collier and Gunning, 1995).


77

4.3 REGIONAL INTEGRATION IN AFRICA Most of the current regional integration groupings in Africa have been in existence for over 30 years. The major regional economic integration agreements in Africa are summarised in Table (4.1.) Table 4.1 shows that there are currently 9 major regional integration schemes in Africa. In order to assess the feasibility of a "United States of Africa" one must judge the success of these schemes in contributing to the economic development of their member states. A large literature exists on regional integration in Africa (see e.g. Yeats, 1998). From this literature, it seems fair to draw out the following "stylized facts" of African regional integration. First, despite decades of regional integration agreements intra-regional trade still comprises only 12% of total African exports. Second, in the trade patterns amongst African countries, trade between only 5 countries completely dominates intra-African trade (excluding South Africa). These are Cote d'lvoire, Nigeria, Kenya, Zimbabwe and Ghana. Together the trade between these 5 countries account for over 75% of intra-regional trade. Third, four products dominate African intra-regional trade. None are manufacturing goods but all are commodities namely petroleum, cotton, maize and cocoa. These commodities are responsible for 50% of intra-African trade. Fourth, despite decades of regional integration, the percentage of intraregional trade in Africa has not increased significantly. In other words, there is little evidence that regional integration in Africa has lead to trade creation. Table (4.2) below summarized the percentage share of intra-regional trade in the various regional integration groupings in 1970, 1985 and 1993. Table (4.2) indicates that in over 30 years, the movement towards regional integration has done little to contribute to trade amongst African countries. In major groupings such as the PTA and SADC, trade has actually declined in percentage terms. This suggests that African countries' trade with the rest of the world has been increasing must faster than intra-regional trade. Other evidence seems to suggest that this integration of Africa with the rest of the world (outside Africa) is not only a pattern in trade in goods, but also in terms of capital markets - for instance through capital flight from the continent. It has been estimated that up to 30% of the wealth of Africa could currently be held outside the continent. Fifth, if one considers the imports of SSA countries, almost 75% of this consists of capital goods such as machinery and transport equipment. The current economic structure of SSA countries is such that they have very little capacity to meet these needs and many African countries show a Revealed Comparative Advantage (RCA) in the same products. In other words, there seem to

78


Table 4.1. Regional Integration Agreements in Africa

4 THE GLOBAL INTEGRATION OF AFRICA REGIONAL GROUP CIIPGL ECCAS

1970

1985

1993

0.4% 2.4%

0.8% 2.1%

l.luo

2.5%

ECOWAS

3.0%

5.3%

8.6%

MRU PTA

0.2% 9.6%

0.4% 5.5%

0.0% 7.0%

SADC

5.2%

4.7%

5.1%

UDEAC

4.9%

1.9%

2.3%

UEMOA

6.4%

8.7%

10.4%

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Table 4.2. Percentage Share of Intra-Regional Trade in Africa, 1970-1993 be very little motivation for African countries to trade with one another given the lack of complementarity in trade patterns. The above overview of regional integration has shown that regional integration in Africa is unlikely to lead to substantial trade between African countries. As supported by Yeats (1998) this make less compelling arguments that regional trade can help overcome problems of small domestic markets in African countries. Moreover, if the contributions from the new theory of regional integration are correct, then indeed regional integration may present Africa with a lose-lose situation. These will be outlined in the next section.

4.4 AFRICA AND THE THEORY OF REGIONAL INTEGRATION Viner (1950) had made the economics of regional integration the classic contribution towards understanding. Viner coined the terms trade creation and trade diversion to determine in which instances it would be beneficial for countries to engage in regional integration. Baldwin and Venables (1995) contain a good overview of the subsequent literature on understanding trade creation and trade diversion. The practical experience of various regional integration agreements has supported the implication in Viner's and other's work that the effect of regional integration on the welfare of a participating country may be ambiguous. Venables (1999) point to the experience of the EU where regional integration has led to convergence of per capita incomes amongst member states. However, in ECOWAS and other agreements regional integration has led to divergence in per capita incomes.

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To predict whom gains and who loses in a regional integration agreement, Venables (1999) has recently integrated two strands of research, namely research on the comparative advantage of countries and research on the importance of agglomeration forces. With reference to the former strand of research, Venables (1999 p: ii) concludes: "Typically, the country in the free trade agreement (FTA) that has comparative advantage most different from the world average is most at risk from trade diversion. Thus, if a group of low income countries form an FTA, there will be a tendency for the lowest income members to suffer real income loss due to trade diversion. In contrast, if an FTA contains a high income country (relative to other members and to the world average) then lower income members are likely to converge with the high income partner." Venables' contribution to incorporate agglomeration forces into the understanding of regional integration is a useful contribution that contains vital insights from the so-called new economic geography. Given the great concern in Africa about the continent's lack of manufacturing development, it is necessary to provide a more detailed explanation. Regional integration may lead to welfare-inducing changes in the agglomeration of economic activities in member countries. This is because regional integration (through for example a FTA) makes it easier to supply consumers from a few locations. This would lead to the relocation of industries in either one of two ways, each with different implications for convergence of divergence of per capita incomes between countries. The first is when the regional integration causes particular sectors to become more spatially concentrated - e.g. a certain country experiences an agglomeration on financial services, another of manufacturing enterprises, another of commercial agriculture, etc. In such a case, despite adjustment costs, the net effect of regional integration may not necessarily be greater inequality between countries. If however, regional integration leads to manufacturing as a whole to cluster in a few locations, it may lead to the de-industrialisation of less-favoured regions. This will lead to divergence in per capita incomes amongst member states. As shown by Venables (1999) this is more likely to occur if manufacturing as a whole is a small share of the economy - as in most African economies. The agglomeration forces described above may interact with competitive advantage forces. Specifically, agglomeration may accentuate the competitive advantage force in the direction of divergence in the case of developing countries (Venables, 1999).


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The conclusion from the above analysis, when combined with the stylized facts on African regional integration is that regional integration schemes amongst African countries could lead to divergence in incomes due to agglomeration forces, as well as the comparative advantages that will be enjoyed be only a few countries. Schiff (1999) extends the theory of regional integration by asking not whether regional integration should be pursued or not, but that if it is persued, what criteria should be used by countries to decide on a partner country or block. This question is relevant in the present context, since if it is the case that regional integration amongst African countries could lead to divergence in per capita income, and regional integration with higher income countries are preferred, the decision should be made with what country? Schiff (1999) shows that pre-FTA (Free Trade Area) volume of trade is not a useful criterion for selecting a partner bloc. Instead he concludes that: •

A home country will be better off with a large partner country (or bloc). This is because a large partner country is more likely to satisfy the home country's import demand at world prices. Thus for SADC countries it will be better to integrate with Euroland that South Africa.

•

The FTA as a whole is likely to be better off if each country imports what the other exports (rather than each country importing what the other imports, as was shown in section 3 to be the case in Africa).

The recommendation from the above is that African countries should pursue unilateral trade liberalization on a most favoured nation (MFN) basis as a preferred strategy to regional integration, with a FTA with a higher income region the second option. However, it must be added here that this does not mean that regional integration groupings such as those listed in section 3 should necessarily be abandoned. There is a strong case to be made for the maintenance and expansion of these. This is because there is empirical evidence that significant "neighbourhood" effects exist in Africa. Easterly and Levine (1995) has found that there are significant spillovers of growth performance between neighbouring countries in Africa. They conclude that if neighbouring countries in Africa act together to improve economic policies and political stability, the effects on the growth rates of all are much greater. Specifically, the results suggests that the effect of neighbours adopting a policy change (e.g. opening up trade) is 2.2 times greater than if a single country acted alone.

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4.5 THE SOUTH AFRICAN-EUROPEAN UNION FREE TRADE AGREEMENT The establishment of the South African-European Union free trade agreement (SA-EU FTA) embodies a milestone in history. For the first time a FTA incorporates an overall concept of development and cooperation. Literately, the protocol is named an Agreement on Trade, Development and Cooperation (TDCA) which is premised on democratic, human rights, and rule of law principles. It involves different economical and societal realms, which will provoke South Africa's economy to compete on a global scale. The Agreement reflects a new approach towards North-South economic integration. As Keet (1996) puts it, this form of integration will function as a pilot project which, if successful, could equally be projected onto other countries. From its' initial talks to its final implementation a period of four years had passed before the Agreement went into force by 1st January 2000. Admittedly, spurred by the political reforms in 1994 South Africa commenced opening up its economy by joining SADC and gaining access to the most preferred conditions under the Lome Convention6. Not surprisingly, the EU first turned down the access to Lome for South Africa in November 1994. EU's major reasoning was that South Africa would not suit as a strong, developed and middle-income country among the other 70 member nations. However, the EU was aware of South Africa's landmark within the Southern African economic environment and hence admitted South Africa to Lome under a qualified membership status in 1997. In reality, South Africa was already granted access to the Generalized System of Preferences (GSP) and hoped to climb up all tiers of the EU's pyramid of privilege in order to gain best access conditions to the European market. Despite all concessions and the twin-track approach by the EU a bilateral reciprocal free trade agreement was proposed to South Africa in 1995. The SA-EU TDCA promotes a framework for an unlimited period of cooperation between the two parties. A mutual Cooperation Council will be established to settle any disputes like anti-dumping and intellectual property issues arising from the Agreement. It will also review latest developments 6

A European Union preferential trade arrangement and multilateral development aid program with the ACP countries (most of the former European colonies) to allow for free trade access to the European market (Lome I signed in 1975). Lome functions as an unilateral trade concession from the EU to all Lome members. In addition, international loans by the European Investment Bank (EIB) and development aid are available.


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and pursue further trade liberalization. Additionally, the free movement of commodities and capital including the free flow of trade in services are the objectives of the FTA. eralion Agreemtnl bctwecn SA - EU 1 i*,U. 1 j L velopmen t a'nä' 'Coop Development of Free Trade Area Economic Cooperation Trade Cooperation Social & Cultural Cooperation

Institutional framework Development Cooperation Financial Assistance Political Dialog

Table 4.3. Main Aspects of the SA-EU Free Trade Agreement Source: Bundesstelle für Außenhandelsinformation, 1999.

•

Economic Cooperation

Article 50-64 enumerate the fields of cooperation in postal, energy, mining and minerals, transport, tourism, agriculture and fisheries, services, consumer policy and protection of consumer health. It promotes and assists domestic industry, investment and tries to avoid double taxation. Finally, information and telecommunication technology will be provided. •

Development Cooperation

Development of sustainable private enterprises for regional cooperation and integration, with focus on neglected communities, genders and environmental dimensions as well as support of progressive integration into the world economy are ratified in Article 65-82 in the protocol just like the essential expansion of employment. •

Trade Cooperation

Trade development means transfer of know-how and technology through investment and joint ventures. The exchange of information and the promotion of small and medium sized enterprises (SMEs) will have priority. Other fields of cooperation include environmental, cultural, societal and health issues to provide necessary support at every stage of the society and upgrade SA's status. Gundlach (2000) suggests that in order for free trade to be welfare enhancing trading partners do not have to liberalize all at the same time. Thus, the SA-EU FTA has implemented the principle of asymmetry and differentiation. In this context, the EU has committed itself to liberate its tariffs at a faster pace than South Africa. Specifically, the EU is going to liberalize 95 percent of its South African imports over a period of 10 years whilst South Africa will do so for 86 percent respectively. Of course, the reciprocal process of liberalizing tariffs on bilateral trade has to be in accordance with the WTO rules on

84


FTAs that asks for the abolishment of duties on substantially all trade over the period of 10 years. Again, most South African commodities already entered favourably the EU under the GSP conditions. For example, 57 percent of South African exports to the EU in 1997 entered the EU market duty free on a MFN basis and 28 percent enjoyed GSP status. Consequently, a total of 85 percent enjoyed free market access prior the TDCA. Notably, 20 percent of agricultural and 80 percent of industrial products were eligible for duty free provisions. It follows that the EU does not have to liberalize at the same degree as South Africa. As a matter of fact, SA will have to get rid of 86 percent of its total imports from the EU due to the TDCA as Davies (2000) explains. Since the Agreement focuses on tradable and non-tradable goods, it remains to be emphasised that the major attention was directed towards industrial and agricultural products. Between the two product groups comparative advantages of trading partners are reflected. South Africa advantages lie in natural resources, textile, agricultural produce, and wine and in the vehicle assembly production and a diversified pool of human capital, whereas EU's edges are in technology, skills and capital. Apparently, the EU with its 15 member states incorporates a very protected and subsidized agricultural sector, run by its Common Agricultural Policy (CAP). In light of the established agreement it is interesting to recall the findings from the IMF Staff Country Report on South Africa (2000) which argues that about one-fourth of all tariff lines which are exempted from tariff elimination are in sectors of the highest tariffs. To foster South Africa's location advantage decisive intellectual rights, antidumping, safeguard, repatriation possibilities and investment protection where also taken into account of the Agreement. Equally important are the special reserve lists or negative lists. Issues on port and sherry, fisheries, cut flowers, footwear and tyres as well as the automobile industry regulations culminated in tough rounds of negotiations even after the ratification of the protocol. For these sensitive products particular tariff quotas were established. Davies (2000) argues that in terms of success in the negotiations, South Africa brought down the percentage of agricultural products excluded from the TDCA from 46 to 26 percent. With respect to Jovanovi (1992) who postulates that free trade areas tend to include manufactured goods but neglect agricultural products in general such an achievement needs to be stressed. Rules of origin prohibit the deflection of trade and make up for the special feature of FTAs. They describe the local content of a product originating in a member country. They are not only about customs control, but about


85

economic development, jobs and investments Smalberger (2000) noticed. The instrument of cumulation of rules of origin allows to source inputs, to a certain degree, from other countries. In that regard, the TDCA provides for diagonal/partial cumulation between the EU and SA but also among SACU and ACP states. Furthermore, an applied tolerance rule of 15 percent permits to source from third countries except for products like textiles, fish, tobacco and alcohol. To make explicit statements on the possible impacts from the established FTA it needs to be recapitulated that the tariff phase down will run until 2012. Even then, there will be further negotiations on pending duties. Hence, only general assumptions can be stated. Also, at this stage the outcome from NAFTA, for example, can only be evaluated in the medium run since it will phase out in 2004. In this context, economic literature offers mainly ex-ante rather than expost analysis. Notwithstanding, Teljeur (1998) employed the static and partial equilibrium SMART model which is a simulation tool provided by UNCTAD to gauge the quantitative impacts caused by the SA-EU FTA. It chiefly focuses on the tariff liberalization and neglects other forms like rule of origin, non-tariff barriers (NTBs) and physical quotas. Generally, it also lacks the dynamic effects of FTAs which need to be taken into consideration when discussing trade creation or trade diversion effects in real terms. For it is acknowledged that dynamic and geopolitical advantages offset the direct and static costs of such an Agreement. It was found that the trade creation effect would not significantly impact on South African exports. The negotiated tariff reductions are prone to induce only 0.8 percent of additional trade. In comparison to a potential rise between 2.3 to 12.3 percent share for the EU's respectively. Moreover, it is believed that South African imports from the EU will surmount its' expected exports. It is criticized that 135 very trade sensitive commodities which account for much as 50 percent of South African farm products were expelled from tariff reduction. Despite the fact that SMART is limited to merely import and export projections, it nevertheless offers a sound tool for specific trade negotiations. There is a wide discussion on South African adjustment costs emanating from the Agreement. Davies (2000) also expects revenues from customs duties to diminish on a large scale due to the removal of duties on total imports. Concurrently, training and development is necessary to secure a smooth operation of the customs regulations like the handling of statistics, disputes, etc.

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The TDCA provides opportunities especially for the manufacturing industry. Davies (2000) enumerates steel and steel products, ferro alloys, aluminium products, furniture and automotive products as potentially significant beneficiary industries. Possibilities of establishing completely new industries to produce for the EU, South African and SADC markets will also be opened up by the Agreement. This will entail high potential for both domestic and foreign investors in industries to utilize SA as a platform for entry into the European market. The main trading countries in Europe with South Africa listed by importance are inter alia: Germany, the U.K., Netherlands, Belgium, Italy, and France. Germany accounts for almost 40 percent of SAs' imports and about 420 German firms are located in SA. The trade flows in the last decade presented in Figure 4.1 also point out that despite a constant trade balance of 2 percent on total trade with Africa, South Africa benefited from its German trading partner in terms of rising imports. In 1999, German imports rose 17.2 percent to DM 4.9 billion compared with the previous year, and a 3.1 percent slowing in exports could be reported the by Bundesministerium fur Wirtschaft (1999a) (German Ministry of Trade and Commerce) respectively.

German Imports/Exports with South Africa 7000

:

6000

rExports

s

c 5000 o

1 4000 ~ 3000

^ ^ • ' • ^ ^ ^

^——

_^ " * ^

Imports

2000 o en

00

IO 00

o>

o en en

CO 05

co

CO

in CO

CO en Years

CO CO CO

s. CO CO

00 CO CO

CO CO CO

Fig. 4.1. German Trade Development with South Africa

Source: Bundesministerium fur Wirtschaft 1999b, pp. 96-97; Michler, Walter 1991, p. 47; Statistisches Bundesamt 1995, p. 133; a= Statistisches Bundesamt 2000, p. 285.


87

In retrospect, from 1996 to 2000 South Africa progressed significantly in terms of its competitiveness as the Global Competitiveness Report 2000 by the World Economic Forum shows. South Africa moved from 43th to the 33th place among listed members. Economist derive the surge and alteration of its export composition in macroeconomic terms due to the general export incentive scheme (GEIS) from 1990 and more recently from the growth, employment and redistribution programme (GEAR). Importantly, Davenport and Page (1991) noted that any trade diversion effect will have essential consequences for investments in general. They assert that investment in developing countries has mainly taken place to capitalize on natural resources or to supply rapidly growing local markets. Relative advantages over competitors is said to be realized particularly in industrial products which already cover 86 percent of South African outright export. Jenkins and Naude (1996) noted that South Africa's membership of SACU and SADC does not necessarily deter South Africa to enter into an agreement with the EU or other trading blocs. Hence further regional integration of South Africa can be expected in the near future. The establishment of a FTA among SADC members before 2004, and the possibility of signing a FTA with MERCOSUR are two examples. Jenkins and Naude (1996) argue in favour of the SA-EU FTA. Improvements in welfare, trade diversification, protection from anti-dumping suits and they predict more favourable rules of origin. They further assert that the FTA will create welfare gains for the whole of Southern Africa. It is further suggested that South African neighbouring countries should support the SA-EU FTA as it will furnish benefits in form of surging investments and two-way trade. In this context, Harvey (2000) names five fundamental insights which are due to a study conducted by the Institute of Development Studies (IDS) in the United Kingdom and the Botswana Institute for Development Policy Analysis (BIDPA). Initially, a greater competition within the SACU market and for the BLNS7 production exports caused by EU imports might occur. Equally significant is the potential customs revenue loss, the indirect impacts on the changing of South Africa's economy, and finally the altering FDI flows to BLNS countries. Yet, the overall effects have been found to be relatively small, besides the possible loss of customs revenues; Davies (2000). Adjustment costs for the BLNS states engendered by the increasing competition will also be partially compensated and taken into account during further ACP talks by the EU. 7

BLNS refers to the following countries Botswana, Lesotho, Namibia and Swaziland.

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Certainly, companies in either South Africa or the EU will have to face the impacts on the Agreement. First and foremost, for the EU South Africa is the most important trading partner in Africa. These relations will tighten and allow European companies to capitalize on the demand for diversified commodities in South Africa. Joint ventures, mergers and acquisitions (M&As) as well as takeovers offer sound possibilities for expansion. Apart from technology transfer export activities will improve. Table 4.4 shows the pro and cons for corporations due to the bilateral agreement. Advantages

Disadvanta»es

Access to the EU market for an unlimited time frame

Increasing imports from the EU

Cooperation FTA

Non-tariff barriers (NTBs) are

Development Assistance

not explicitly addressed

Upgradiög of Trading System

Threat of hostile takeovers, M&As

Provides FDIs for expansion

Efficiency of S As customs work

Entail new industries Increases Competitiveness Creates new opportunities Table 4.4. Corporate Implications of the EU - SA TDCA Source: Van Heerden (2000:96).

Valentine and Krasnik (2000) identified specific export sectors for South Africa and SADC countries based on Balassa's formula of comparative advantages. They found that nearly 50 percent of the total SADC trade, in terms of weighted annual growth rates, were destined for Brazil, China and India. In turn the growth rate of the EU and USA presented only low rates. The butterfly strategy, developed by the Department of Trade and Industry in 1996, reflects South Africa's international integration want. Eastwards India, Ocean Pacific and Asian countries are targeted. Westwards South American, Latin and Atlantic countries open up new opportunities. Most importantly though, its orientation to Africa and Europe will push South Africa to become more competitive in other markets. Most importantly, Valentine and Krasnik (2000) list countries by comparative advantages of export commodities, which could be a source for increas-


89

ing export revenues. In particular, transport equipment, petroleum products, non-metallic mineral manufactures, manufactured fertilizers, furniture, essential oils, crude rubber, dyeing and tanning, and cereals are identified sectors showing improving status. In that regard, the top five sectors found by Valentine and Krasnik (2000) are machinery and transport equipment; electrical and office machinery; miscellaneous edible products; and essential oils and perfume materials. Also Wakeford (2000) foresees great business potential especially in herbal, indigenous, and homeopathic remedies as well as in the mix of cultural groups which support and maintain great opportunities for eco-tourism. These sectors are also seen to prosper further from the access to the European market. Strategically, South African companies will have lower trade barriers than firms located outside the FTA. This will according to McCarthy (1999) enable businesses to expand, distribute and diversify production. Additionally, he assumes that "agglomeration economies will.. enablefirms,especially those that produce relatively high value, low mass products, to sell in the larger (European) market regardless of the transport costs involved." Transport and shipping entities such as airports, sea freight and land transport businesses will entail fundamental changes. Like other recent studies, a study conducted by the African Development Bank in 1993 identified Tanzania, Zimbabwe, Zambia, and Angola with chemicals, Pharmaceuticals, paper and board, fabrics, metals, machinery, cars, and furniture as growth segments for Southern African trade in terms of the African market. The perception of the FTA from German MNEs in South Africa is demonstrated in a qualitative study provided by Bauer (2001). His general acquired insights are gathered here: • • • • • •

Companies did not regard the Agreement as very important for their business. Strategic planning will not be effected by the impacts of the FTA. The trade cooperation and economic cooperation appears to be of utmost significance, for the current trade between the South Africa and the EU is perceived as trade restrictive or trade neutral. All companies believed that the Agreement will have an positive or neutral effect on South Africa's economic development. Most businesses are not sure about improvements in employment, only few are determined that the FTA will encompass an effect on job creation. An increase in FDIs can be expected in 2005 by German companies which coincides with the first reviewing of the SA-EU FTA.

90


•

Most beneficiaries of the SA-EU FTA are the following industries by importance: (1) tourism, Pharmaceuticals, telecommunication; (2) airports8, security services, manufacturing and agriculture; and (3) computer industry and banking. • Tourism entails most opportunities together with the automobile, chemical, trading and consumer goods industry like food and nutrition. • Negative impacts for the SADC members are expected to be of very low impact. Even the potential enlargement of the EU is not feared and viewed as a potential advantage for the South African economy due to the gain of further market access power. To conclude, the negotiated agreement incorporates a facet of societal, political and economical realms with the establishment of a mutual benefiting FTA at its heart. The SA-EU FTA proves to be of positive net benefit to South Africa, as it pertains a relatively developed and diversified industrial sector. Indeed, major export revenues are still being generated in the primary sector but there is a change in the trade composition already visible. Without doubt, the FTA with the EU will be a new initiative for the North - South economic relations. The conclusions from the findings suggests that German companies in Europe or South Africa benefit from the TDCA as trade between the partner countries will continue to increase. The introduction of the Euro in 2002 does also champion this argument. Opportunities in tourism, automobile and chemical industry are expected to prosper predominantly. But economic integration will be useless if, in the end, the dynamic effects will not result in an improvement of the social conditions on the premise of sustainable development processes.

4.6 PERCEPTIONS OF THE SA-EU FTA AMONGST GERMAN MNEs IN SOUTH AFRICA9 The questionnaire contains two sections. The first section asks for general environmental, business related and investment issues. The second section attempts to identify the corporate view of the EU-SA FTA and its efficiency. The questionnaire was mainly addressed to German companies operating in SA. The following summary will highlight some insights. Nevertheless, one needs 8

The increasing two-way inter-continental business interactions led to a surge in airway traffic valuing hundreds of billions of Rands a year. See Nevin, (1997:11). 9 The authors would like to thank especially Udo Meinecke from KPMG, Johannesburg as well as Ulrike Foschetti from the South African - German Chamber of Commerce and Andreas Berger from Gerling General Insurance of South Africa Ltd. Johannesburg who supported this quantitative study and facilitated some useful discussions with Siemens and Deutsche Bank.


91

to be conscious about the qualitative value and its fundamental impact. Only an impression of the overall findings can be presented. Furthermore, primarily the outcome from the sections which were answered by all firms shall be enlightened. Initially, the nine responding firms shall be grouped into A, B, and C. Notably, each family contains three businesses. Group A refers to companies established in the 1990s. Firms founded in the 1970s and 80s are gathered in group B. Finally, companies of group C have been in South Africa since the 1950s and 1960s. For the purpose of this study the size of the company shall be ignored and section one shall be addressed merely briefly. The total outcome of all groups from the first section points out that onethird of all companies operate as a different type from its parent company in South Africa. Four out of nine firms showed great diversification and operate in various sectors of the market. Mostly machinery, chemistry, construction and consulting activities were marked. The overall trading activities tell that Africa (7), Europe (2) but also Arab and North American countries are the final destination of South Africa's exports. On the import side, Europe (8) and North America (4) are the major locations for sourcing10. South Africa's relative comparative advantage has been identified in marketing, inexpensive labor and location advantages. Six firms engage in exports and most companies characterized their investments as expansion oriented (4). Regarding investment activities four companies planned to engaged in investments in 2001 and the same amount planned to do so in 2005. This mirrors also the operative (4), tactical (1) and strategic (3) investment behavior. Local production (7), direct export (5), export via distributor (3) and irregular export (3) make up for the companies' prime activities. Here, the introduction of new products (8), cost minimization, increasing marketing and export (each 5) are the main corporate strategies for operating in South Africa. Of high importance to almost all firms are the qualification of its work force, the political stability, infrastructure and financial means like currency convertibility and expatriation regulations. The current economic situation of the firms covers the whole spectrum of all realms from excellent to risky and does not show a tendency. However, six firms foresee only medium potential of operating in South Africa, since the competition is viewed as very intense (3) and high (5). By groups, A's main activities are combined with consulting (2) and all three firms operate on a strategic investment plan. Interesting for group B was merely the perception to be exposed to a very intense (1) or high (2) competition. The same is valid for group C, yet they present a shift in their corporate strategies towards increasing imports form other markets, which may well had the EU-SA FTA as a trigger. 10

Various options could be marked at some questions thus the total number does not have to be nine all the time.

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Coming to the focus on section two and the quantitative results from the EU-SA FTA survey the first question regarding the knowledge of the Agreement showed that only four firms were familiar with its content. Partial (2) information or even no (3) information on the TDCA was also rather significant. Surprisingly, no firms regarded the Agreement as very important. Only three found it important, two less important and four not important at all. Therefore, it is understandable that five firms mentioned that they would not take the impacts of the FTA into their account for strategic planning. Just three companies will do so however only partially and one does totally. The trade cooperation (5) and economic cooperation (3) appears to be of utmost significance, for the current trade between the EU and South Africa is regarded as trade restrictive (3) or trade neutral (6). Nevertheless, all companies believe that the Agreement will have a positive (6) or neutral (3) effect on South Africa's economic development. Albeit most businesses (5) are not sure about improvements in employment, few (3) are determined that the FTA will encompass an effect on job creation. Benefits like technology transfer and a more competitive export price are expected to result within their companies. Potential detriments are increasing competition and a reduced mark up for operating firms. An increase in FDIs through the questioned firms can be expected in 2005 that coincides with the first reviewing of the EU-SA FTA impact. In this context, European (2) and African countries (2) were marked for countries seeking South Africa for FDI activities and market access. The four categories of infrastructure, education and training, crime reducing activities and housing stand out as urgent fields of society to be supported by EU's development projects. Most beneficiaries of the EU-SA FTA are the following industries by importance: Firstly tourism, Pharmaceuticals, telecommunication; secondly, airports11, security services, manufacturing and agriculture; and thirdly, computer industry and banking. In other words, the tourism sector entails most opportunities together with the automobile, chemical, trading and consumer goods like food and nutrition. Negative impacts for the SADC members are not expected and if then to be very low (5). Even the potential enlargement of the EU is not feared and genuinely viewed as potential advantages for the South African economy due to market access reasoning. By groups A shows similar opinion like the aggregate conclusions. In contrast to group B, a very pessimistic view to the impacts of the Agreement appeared. The current trade regulations were held to be very restrictive (2) or neutral (1) by group C. Moreover, they believe that the applied form of integration might be able to cause an increase in employment.

11

As mentioned above the increasing two-way inter-continental business interactions led to a surge in airway traffic valuing hundreds of billions of rands a year. See Nevin, Tom, 1997, p. 11.


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By and large, the results of this study give an ostensible picture of the perception of the FTA between the EU and South Africa by German firms in the Republic of South Africa. Despite the small number of returns it becomes clear from the earlier sections that trade between the two partners will promote EU's exports and South Africa's economic development. Relatively small detriments for SADC or SACU members are expected.

4.7 CONCLUSIONS This chapter critically assessed, from an economic point of view, the potential of regional economic integration amongst African countries for promoting economic development in Africa. It did so by considering the recent explanations for Africa's poor economic development and by assessing the African experience with regional integration. The insights from this analysis were combined with recent theoretical advances in understanding the extent to which economic integration schemes leads to divergence or convergence of per capita incomes amongst members states. It may be concluded, with reference to the recent Free Trade Agreement between South Africa and the EU, that integration amongst African states may be sub-optimal to integration between African states and a higher income region (e.g. the EU). Specifically, regional trade agreements between SSA countries could be of limited value and could even lead to trade diversion and a divergence of per capita incomes amongst member states. Older arguments for African regional trade integration agreements centred round the lack of market size in individual African countries. However, given the WTO's GATT, the Lome Agreement with the EU and the Generalised System of Preferences (GSP), little external obstacles to finding markets for African countries' products still exists. The recommendations following from this paper is therefore that instead of first and foremost promoting regional integration and/or a United States of Africa that African policy-makers focus on the following: •

The liberalisation of import barriers on a most favoured nation (MFN) basis to increase the openness of their economies; • The concluding of a Free Trade Agreement (FTA) with high-income country (-ies) in the form of North-South regional integration. The South African FTA with the EU and possibility of extending this agreement to SADC offers a starting point. • The use of regional integration agreements not with the primary expectation of leading to increased trade or regional convergence, but to achieve

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W. NAUDE, W. KRUGELL and N. BAUER mechanisms of co-operation between African countries in terms of macroeconomic policy making and for providing a politically and economically stable environment to facilitate the repatriating of the huge amounts of African wealth currently held outside of the continent.

The advantages of the above strategy are that trade creation takes place that could facilitate convergence between African per capita incomes and that of the rest of the world, that Foreign Direct Investment and technology transfers are raised, that cheaper inputs needed can be sourced and that a lock-in (commitment) mechanism is created for reducing the risk of African countries reneging on trade liberalisation. It also alleviates the problems of negative neighbourhood effects in Africa. The call made in this paper is therefore that African states should focus on economic integration with countries outside of Africa for expansion of trade and for obtaining technology and investment, and should expect of economic integration agreements amongst themselves not to lead necessarily to greater trade, but to enhance economic policy co-ordination and the adoption and maintenance of sound macro-economic policies and governance practices.

REFERENCES Aghion, P., Howitt, P. (1992). A Model of Growth Through Creative Destruction, Econometrica, 60 :323-351. Baldwin, R., Venables, A.J. (1995). Regional Economic Integration (In: Grossman, G., Rogoff, K. eds. Handbook of International Economics, Vol. 3. Amsterdam : North Holland). Barro, R. (1990). Government Spending in a Simple Model of Endogenous Growth, Journal of Political Economy, 98(5) : 103-125. Barro, R. (1991). Economic Growth in a Cross-Section of Countries, Quarterly Journal of Economics, 106(2). Bauer, Norbert (2001). The EU-SA Free Trade Agreement - Impacts on German Multinationals, Unpublished Paper: University of Paderborn. Bundesministerium fur Wirtschaft (BMWi) (1999a). Deutscher Aufienhandel mit Afrika 1999, Baden-Baden: Koeblin. Bundesministerium fur Wirtschaft (BMWi) (1999b). Wirtschaft in Zahlen '99, Baden-Baden: Koeblin, Online available at URL: http://www.bmwi.de from 5 October 2000.


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Bundesstelle fur Aufienhandelsinformation (bfai) (Hrsg.) (1999). Siidafrika. Amtliche Texte. Abkommen iiber Handel, Entwicklung und Zusammenarbeit zwischen den Europaischen Gemeinschaften und ihren Mitgliedstaaten einerseits und der Republik Siidafrika andererseits, ZHI Nr. 28, Koln: bfai. Collier, P., Gunning, J.W. (1995). Trade Policy and Regional Integration: Implications for the Relationship between Europe and Africa, The World Economy, 18: 387-410. Collier, P. Gunning, J.W. (1999). Explaining African Economic Performance, Journal of Economic Literature, 37. Davenport, Michael and Page, Sheila (1991). Europe. 1992 and the Developing world, London: Overseas Development Institute. Davies, R. (2000). Forging a New Relationship with the EU, in: BertelsmannScott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 5 -16. Easterly, W., Levine, R. (1997). Africa's Growth Tragedy: Policies and Ethnic Divisions, Quarterly Journal of Economics, 112 (4): 1203-1250. Gundlach, Erich (2000). Globalization. Economic Challenges and the Political Response, in: Intereconomics. Review of International Trade and Development, Hamburg: HWWA, Vol. 35, May/June 2000, pp. 114 -126. Harvey, C. (2000). The Impact of the Agreement on BLNS, in: BertelsmannScott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 83 - 93. International Monetary Fund (IMF) (2000). South Africa. Selected Issues, IMF Staff Country Report, No. 00/42, March 2000, Washington, D.C.: IMF, Online Available at URL: http://www.imf.org. Jenkins, Carolyn, and Naud, Willem (1996). Reciprocity in Trade Relations between South Africa and Europe, in: Development Southern Africa, Vol. 13, No. 1, February 1996, pp. 17 - 30. Jenkins, C, Thomas, L. (1999). What Drives Growth in Southern Africa?, CREFSA Quarterly Review, 1: 2-11.

96


Jovanovic, Miroslav N. (1992). International Economic Integration. Limits and Prospects, 2nd Edition, London: Routledge. Keet, Dot, (1996). The European Union's proposed free trade agreement with South Africa. The implications and some counter-proposals, in: Development Southern Africa, Vol. 13, No. 4, August 1996, pp. 555 - 566. McCarthy, C.L. (1999). Polarised Development in a SACD Free Trade Area, in: The South African Journal of Economics, Vol. 67, No. 4, pp. 375 - 399. Michler, Walter (1991). Weifibuch Afrika, 2. Auflage, Bonn: J.H.W. Dietz. Ng, F., Yeats, A. (1999). Good Governance and Trade Policy: Are They the Keys to Africa's Global Integration and Growth?, Policy Research Working Paper no. 2038, Washington DC: The World Bank. Nevin, Tom (1997). SA's Business Army on the March, in: African Business, June 1997, pp. 7 - 12. Romer, P.M. (1986). Increasing Returns and Long Run Growth, Journal of Political Economy, 94(5) : 1002-1037. Sachs, J., Warner, A. (1995). Economic Reform and the Process of Global Integration (In: Brainard, W., Perry, G. eds. Brookings Papers on Economic Activity, 1.) Sachs, J., Warner, A. (1997). Sources of Slow Growth in African Economies, Journal of African Economies, 6(3). Sala-I-Martin, X. (1997). I Just Ran Two Million Regressions, American Economic Review, Papers and Proceedings, 87(2). Schiff, M. (1999). Will the Real Natural Trading Partner Please Stand Up? Policy Research Working Paper no. 2161, Washington DC : The World Bank. Smallberger, Wilhelm (2000). Lessons Learnt by SA during Negotiations, in: Bertelsmann-Scott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU - SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 48 - 51. Statistisches Bundesamt (Hrsg.) (2000). Statistisches Jahrbuch 2000, Stuttgart: Metzler - Poeschel.


97

Statistisches Bundesamt (Hrsg.) (1995). Landerbericht Siidafrika 1994, Stuttgart: Metzler-Poeschel. Teljeur, Ethl (1998). Free Trade. Does South Africa gain? Impact of the Free Trade Agreement between South Africa and the European Union, in: Trade & Industry Monitor, Vol. 6, July 1998, pp. 1 - 6. Valentine, Nicole and Krasnik, Gena (2000). SADC Trade with the Rest of the World. Winning Export Sectors and Revealed Comparative Advantage Ratios, in: The south African Journal of Economics, Vol. 68, No. 2, June, pp. 266 - 285. Van Heerden, Neil (2000). Implications for South African Business, in: Bertelsmann-Scott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU - SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 95 -98. Wakeford, Kevin (2000). The EU-SA Agreement. Opportunities and Challenges for Business, in: Bertelsmann-Scott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU - SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 99 - 105. World Economic Forum (WEF) (2000). Global Competitiveness Report, Online available at URL: http://www.weforum.org from 15 September 2000. Venables, A. (1999). Regional Integration Agreements: a Force for Convergence or Divergence? Policy Research Working Paper no. 2260, Washington DC : The World Bank. Viner, J. (1950). The Customs Union Issue. New York. Yeats, A.J. (1998). What can be Expected from African Regional Trade Agreements? Some Empirical Evidence, Policy Research Working Paper no. 2004, Washington DC: The World Bank.

Part II

Multinational Enterprises in Africa

THE CHANGING VIEW OF MULTINATIONAL ENTERPRISES AND AFRICA B. M. GILROY University of Paderborn, Germany MGilroySnotes.upb.de

5.1 INTRODUCTION1 Since the seventies, international economic relations have increasingly gained importance. Presently, in addition to an increase in exports and imports, the expansion of business activities from different countries has particular importance. For example, the sales of multi-national businesses are higher than the international trade volume. According to preliminary estimates made by UNCTAD in their World Investment Report 2000, world foreign direct investment (FDI) inflows are expected to exceed US$ 1.1 trillion this year, up fourteen percent over 1999, representing a doubling in just three years. More than four fifths of this year's FDI inflows went to developed countries (see Table 5.1 below and UNCTAD Press Release (7 December 2000)). Western Europe continues to be the largest host region to FDI, receiving an estimated US $ 597 billion. FDI flows to Africa have risen modestly - from $8 million in 1998 to $10 billion in 1999 (UNCTAD (2000)). As some African countries, such as Angola, Egypt, Morocco, Nigeria, South Africa and Tunisia, have attempted to create business-friendly environments FDI has risen. In a recent survey of 296 of the world's largest MNEs carried out by UNCTAD and the International Chamber of Commerce at the beginning of 2000 South Africa and Egypt are viewed as the most attractive African locations (UNCTAD (2000), p. 9).

1

An earlier version of this chapter was presented as an invited lecture at the North-West University on the 14th March 2000.1 have benefited from the comments of the seminar participants as well as from the suggestions received by Prof. Willem Naude, Prof. Wilma Viviers, Prof. Thomas Gries, Prof. Karl-Heinz Schmidt and Norbert Bauer. Also important insights were gained from Andreas Berger of Gerling General Insurance of South Africa Ltd. The usual disclaimer applies.

102

B. M. GILROY

As Rubens Ricupero, Secretary-General of UNCTAD, recently reported business activities of multinational enterprises (MNEs), now numbering some 63,000 parent firms with around 690,000 foreign affiliates and a plethora of inter-firm arrangements and collaborations, spans virtually all countries and economic activities, making international business knowledge a growing necessity even for small and medium sized business enterprises.

1000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000 (a)

• Developed countries

D Developing countries

D Central and Eastern Europe

D Developed countries

D Developing countries

• Central and Eastern Europe

Region Worldtotal Developed countries Developing countries Central and Eastern Europe

1990 209 172 37 1

1991 1992 1993 1994 160 172 226 256 114 113 139 145 43 55 81 105 3 4 7 6

1995 1996 1997 1998 1999 2000 (a) 331 399 473 683 982 1118 204 220 276 495 770 899 112 146 178 178 190 190 14 13 19 20 21 30

Source: UNCTAD, FDI/TNC Database a) Preliminary estimates on the basis of 50 major host countries (22 developed and 28 developing counWes] and Central and Eastern Europe as a region.

Table 5.1. FDI Inflows by Region, 1990-2000 As the international environment continues to change rapidly and become increasingly complex due to structural adjustments that open markets command, the demand for entrepreneurial spirits at all levels of the value-added chain of production is greater than ever. This chapter analyzes the changing view of multinational enterprises in the New World order and their possible effects on Africa. The underlying premise is that many of the activities which are so essential for the success of the new world order implies that African growth through regional integration must be carried out by the private sector, specifically the MNE. After a brief discussion of what a MNE actually is in Section 2, coverage of some highly stylized facts

5 CHANGING VIEW OF MULTINATIONAL ENTERPRISES

103

in Section 3 on the general changing views and theoretical perceptions held on MNEs are presented. Section 4 discusses the general impact of integration and the MNE on Africa. The shadow of AIDS on Africa and MNEs are examined in a short excursus presented in Section 5. The effects of property rights and potential growth for South Africa are proposed in Section 6, followed by a summarizing conclusion in Section 7.

5.2 WHAT IS A MULTINATIONAL ENTERPRISE? Multinational enterprises (MNEs) have often been denned in the literature simply as organisations that engage in foreign direct investment (FDI) and owns or controls value-adding activities in more than one country ( see e.g. Dunning (1974, p. 13), Dunning (1993/96, p.3), Casson (1985, p. 31)). Foreign direct investment is understood to be investment made outside the home country of the investing enterprise, but inside the investing enterprise. Control over the use of resources transferred remains with the investor (Dunning (1993/96, p. 5). McMannus (1972) pointed out that the essence of the phenomenon of international production is not simply the transfer of capital, but rather the international extension of managerial control over foreign subsidiaries. He argued that ownership-based control permits management to allocate resources more effectively than would be possible through the market. Value added simply represents the additional value created through the collective activities that occur as a product moves from raw materials through production to final distribution at each stage of the business process. Various other studies have defined multinationals in alternative ways (see e.g. Aharoni (1971), Lenel (1976), Macharazina (1981)). The editors, J. Stopford and J.H. Dunning, of the The World Directory of Multinational Enterprises(1982, 1992), for example, define multinationality according to three criteria: (1) at least 5 percent of consolidated sales or assets from foreign direct investment, (2) at least 25 percent of the voting equity in at least three foreign countries, and (3) at least $75 million in sales from foreign operations. The top 25 MNEs from developing economies, ranked by foreign assets in 1998 are illustrated in Table 5.2 below. Considering South Africa within this context as a "developing country" or more appropriately as an "emerging economy", Sappi Limited (Pulp and Paper) holds the sixth position and Barlow Limited (Diversified Equipment) position twenty-five. These two enterprises alone employ some 45,000 workers domestically in South Africa. The basic problem with a definition of multinationality is that there is no ideal gauge of foreign activity to suit all circumstances. The measure chosen will either be dictated by the data available or will depend on the question at hand (Clegg (1992)). In order to understand the current day phenomenon multinational enterprise, it is additionally necessary to examine more closely the enhanced usage of alternatives modes of mediating international transactions without equity cap-

104 "c **•

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| | |

1 c

co i n Tin h- co Iflr S

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)

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i n CM

i o m in co o i i CM O

CO CM CM (

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S (D r S
cvs

Number of 1 iritis

Motor Vehicles Metal Products Chemicals & rubber manuf. Pharmaceuticals Electronics Construction & Textiles Transport Finance a.o. services Total

4

1-9 10-19 20- 100-199 200 a.m. Total 99 271 126 145

6

o

5

9

95

115

5.906

6.125

21 345

375 257

3

15

57 185

4 2

3 19

48 120 20

200

190 220

3 4

3 19 10

84

280 260

302 354

31

34 53

6.646

8.094

451 910

T a b l e 8.2. Sample of German Firms in South Africa According to Industries and Firm-Size (Employees) 1999

8 COMPETITIVE INTELLIGENCE

217

100-199 200 a.m. Total Manufacturing industries1' Construction & textiles Transport, finance a.o. services

22

Total

31

71,0

0,3 0,5

6,4 22,6

2,0 2,9

100,0 0,4 0,7

4,8

81,8

100,0

9,9

90,1

100,0

12,8

82,3

100,0

82,1

100,0

5,6

12,6

11,2

Table 8.3. Percentages of German Firms According to Groups of Industries and Firm-Size (Number of Employees) 1999

Most firms surveyed had between 1 and 5 plants (offices) in South Africa. About 96% of firms had between 1 and 5 plants (offices) and 4% had between 6 and 10 plants (offices). In 88% of the cases, firms' products/services were in conformity with ISO requirements. German firms in South Africa behave roughly in accordance with the traditional textbook model of MNEs / FDI. For instance they tend to produce mainly for the domestic market (i.e. their investment decision is not based on using South Africa as a competitive platform for exporting) and as will be shown they pay higher wages that local companies and operate very much within "enclaves" from the local economy- although there are exceptions. For instance, the focus on the domestic market is clear from considering that marketing expenses/ budgets have increased for the last three years. Bearing in mind sample problems, only 4% of all questioned companies are engaging in foreign trade suggesting that German MNEs are in South Africa to service the domestic market and that the country may not be seen to be attractive as a platform for international production. Transport and logistical services in South Africa is seen as having a substantial negative influence on the sales of companies. However, despite this exports have increased by 155% over the past three years indicating the domestic market pressures may be forcing these firms to find other outlets as well3. 3

The major destination of German trade are neighbouring countries as well as Europe and especially Germany. Other importing countries of German manufactured

218

J. CALOF and W. VIVIERS

On average, German companies in South Africa spent R8.06m, R8.91m, and R9.04m on marketing in South Africa for the three consecutive years, 1997, 1998, and 1999, respectively. This shows a significant and steady increase in marketing. Most German firms in South Africa face significant competition. On average, there are 2 competitors per firm with a range of 1 and 3. In total 34 new competitors enter the market per year on average. Prior to reporting on the results of the German MNE study and contrasting these with Calof and Breakspear (1999), Calof (1996) and Calof and Miller (1996) a few limitations of the comparisons are discussed. 1) Within the German MNE study for most intelligence questionnaires, responses were recorded from fewer than 40 firms and as was the case for a few of the variables 29 responses were recorded (from a total of 60 firms), making generalization of the results very difficult. The low response rate on intelligence questions (under 50%) may be indicative of lower level intelligence practices, lack of comprehension of the questions or simply a lengthy questionnaire. This should be investigated in a future study. 2) A direct comparison between the German results and Canadian/U.S. results are difficult as there were several differences in the questionnaire. Each version of the intelligence studies improves on the questions asked in the previous survey. Thus, direct comparisons are done where the questions are somewhat similar. 3) Direct comparisons are also difficult to make due to the different time frame of the studies. The two Canadian studies cited in this chapter were conducted in 1991 and again in 1996, while the German study was conducted in 1999. 4) The firms in the studies are different in terms of size and sector. For example, the Calof and Breakspear (1999) study was dominated by smaller firms (91 employees) coming from the technology sector, the Calof (1996) study had firms from a broad cross-section of industries and averaged 857 employees, the Calof and Miller study also came from a broad cross-section of industries but had on average 15,672 employees. While size is not a barrier to competitive intelligence practices it is correlated with formality of the intelligence process (Calof and Breakspear, 1999).

goods in South Africa are: Mauritius, Malaysia, England, Poland, Spain, Indonesia, Chile, Finland, Tanzania and USA.


219

8.5 SURVEY RESULTS Competitive Intelligence Structure Respondents from the German company survey had been conducting competitive intelligence for on average 10.2 years. Firm's indicated that they did have a formal intelligence program (75%) with 21% indicating that they had a formal competitive intelligence unit. The remaining firms tended to place responsibility for competitive intelligence activities in either marketing (46%) or strategy/corporate level (24%). When asked about how they resourced the intelligence function respondents had 3.7 full time employees and 6.9 part time employees. This is indicative of a more formal intelligence program. How does this compare to Canadian intelligence programs? The following indicates how respondents in the Calof and Breakspear study (1999) responded when asked what best described how they are organized for conducting intelligence: • • • • • • •

Scattered/disorganized (2%) One part time person (23%) Several part time personnel (47%) One full time person (3%) Several full time personnel (2%) CI unit (3%) Integrated throughout the organization (20%)

When asked if they have a formal system, only 11% said yes. These results suggest that the Canadian model of Cl is currently a part time one. However, the Calof and Miller study (1996) is somewhat more consistent with the German results? The following indicates how responded when asked what best described how they are organized for conducting intelligence: 1. 2. 3. 4. 5.

One staff member designated part-time to conduct intelligence (18.1%) One staff member designated full-time to conduct intelligence (14.8%) A few staff members conducting intelligence (21.8%) A separate intelligence department established (19.9) Intelligence function integrated throughout the organization (11.6%) Other (13.9%)

Within this U.S. and Canada study, the CI process averaged 6 years - 4 years less than the German results.

220


These comparisons indicate that the German CI programs tend to have been around longer than the Canadian and U.S. intelligence programs and more formal in orientation. Method of Conducting Competitive

Intelligence

The literature review section described the intelligence project process by breaking it down into five distinct functions - planning, collecting, analysis, communications and management. In the literature review section, To contrast the intelligence process of the German, Canadian and U.S. firms respondents in all studies were asked to estimate the percentage of intelligence time spent on the various intelligence functions. The results of these are presented in table 8.4. The results indicate that there is very little difference in the breakdown of the intelligence process in terms of functions. Minor variances were evident in areas such as collection with Canadians spending more times in the collection process than German and American and U.S. firms spending more time on both Analysis and Dissemination than their Canadian or German counterparts but the order of magnitude of these differences (all under 10%) were insufficient to conclude that there were massive process differences between Canadian, American or German CI practices. Area Planning Collecting Analyzing

German Firms Canadian Firms £L& Firms 12.8 12.1 12.8 35.3 38.1 29.3 23.1 28 31.4

15 12.1 9.8 Table 8.4. Percentage Breakdown Time Spent on Intelligence Functions Disseminating

13.7

Evaluating

15.1

Information

11.3

Sources

Where do companies get their information from in the intelligence process? Both the Calof study (1996) and this one focused on understanding where executives went to get information. Respondents in both studies were asked to rate a variety of sources on a four point likhert scale ranging from 0 (not important) to 3 (very important). The results are presented in tables 8.2 and 8.3. Direct comparisons are difficult for this question as different information sources were presented in both surveys. However, what is evident in contrasting results where similar sources are presented are that both the German and Canadian firms put a higher value on primary sources (people) than secondary sources (archived). This is consistent with good intelligence practices.


illiiiiiillllillli

Results

Associations

2.2

Subordinates

2.2

Focus groups Archival

2.7|

0.9

Competitors

2

Consultants

1.4

Customers

2.3

Government Your

0.7

Government Foreign

0.4

Internet Journalists

1.7| 0.7|

Personnel other dept.

1.8|

Personnel your dept Superiors

1.9| 2.3

Suppliers

2.4

Table 8.5. Information Source Importance for German MNE's

liliiillBllllIIIll lilliiii'ill 2.5 Associates Personal contact overseas Foreign clients Canadian embassy Trade Fair Published sources Multi National Enterprise Partners

2.5! 2.4 1.9 1.8: 1.7i

Foreign Affairs (Ottawa) Associations Provincial Agency International Trade Center Other Government Department Industry Canada Computer Databases Foreign Post in Canada Technical societies Foreign consultants Canadian consultants Banks University U.S. Consultants Library

1.5!

1.6:

1.4 1.3 1.3 1.2 1.1 1.1 1.0'

1.0 .9 .9 .9 .8 .8 .6

Table 8.6. Information Source Importance of Canadian Exporters

221

222


The Canadian firms, where however, more likely to use Government sources (1.9) than were the Germans (.7) while the Germans were more likely to use Associations (2.2) than the Canadians (1.4). These results could point to a more developed government information structure in Canada and a greater presence of industry associations in Germany. Regardless of the explanation it is apparent that there are differences in the information acquisition behaviours of Canadian and German firms that should be investigated in future studies. Where do you go for your international information needs? Please grade according to their importance and use using the following scale: 0 = no use to 3 highly used.

The Extent to Which Some Problems Hamper Intelligence Efforts The final portion of the German MNE CI study looked at problems hampering the intelligence effort. In all, 14 barriers that have been identified in the CI literature were investigated. Of these, nine were also asked in the Calof and Miller study (1996). Participants were asked to assess the barriers on a four-point likhert scale ranging from 0 (no problem) to 3 (major problem). In contrast to previous results in this comparative paper, there were dramatic differences between the Canadian, U.S. and German firms. In virtually every barrier area there were major differences between the groups. For example, top management support was a very minor barrier within the German firms (8.3 - 8.4) but more significant with the Canadian and American companies (2.2 and 1.3); getting people to share information was also much more a significant problem as was integrating information and getting management to use the output. In eight of the nine common barrier areas, U.S. and Canadian firms indicated greater barriers than the German MNE's. It was only in the Feedback area that German firms indicated a more major barrier but by a very narrow margin (1.7 versus 1.5).

8.6 CONCLUSIONS The objective of this chapter was to examine the intelligence practices of German MNE's and contrast these to those found in Canadian and U.S. studies. Taking into consideration the caveats involved in the comparison of these results (different size firms, different sectors and different time frame between all the comparative studies), the results indicate that German CI efforts are slightly more advanced in terms of formality when contrasted to both Canadian and American firms, have been around for a longer length of time and suffer from far less problems. However, in terms of the actual process of conducting intelligence projects, few differences are evident. Canadian's and Germans make similar use of primary information sources, seem to spend a similar

8 COMPETITIVE INTELLIGENCE German study

Calofand Witter

American Companies

Canadian Companies

0.3

1.2

1.3

2.2

1

2

1.7

1.6

Getting people to Share information

1.3

2.2

1.8

1.8

Number ofCI personnel

0.9

1.8

1.6

1.1

Internal politics

0.5 0.8

1.6

1.4

2.3 1.8

Barrtet Top Management support Legal issues

0.6

Ethical issues Integrating CI in the organization

0.9

Getting management to use CI output Credibility ofCI with mangement

0.4

1.5

1.2

Feedback on CI projects Budget Training

1.7 1.1 1.2

1.5

1.4

1.6

1.3

1.5

Counter-intelligence

1.1

1.3

1.1

0.6

223

Table 8.7. Barriers in the Intelligence Process

percentage of time in the different functions of intelligence (planning, collection, analyses, communications, and management).

224


REFERENCES Aguilar, F.J. (1967). Scanning the Business environment, New York: MacMillan. Calof, J.L. (1996). So you want to go international? What information do you need and where will you get it? Competitive Intelligence Review, Winter. Calof, J.L. (2001). The Competitive Intelligence audit guide. SCIP conference, 2001. Calof, J.L., Breakspear, A. (1999). Competitive intelligence practices of Canadian Technology Firms. National Research Council/Canadian Institute of Scientific and Technical Information. Calof, J.L., Miller, J. (1996). Survey of SCIP members intelligence practices. Proceedings of the Society of Competitive Intelligence Professionals, Annual Meeting. Washington, DC. Calof, J.L., Skinner, B. (1999). Creating an Intelligence Society: The Role of Government in Competitive Intelligence. What's Happening In Canada? Competitive Intelligence Manager, Spring. Calof, J.L., Viviers, W. (2001). Adding Competitive Intelligence to South Africa's Knowledge Management Mix, Africa Insight, (31)2, June: 61-67. Calof, J.L, Viviers, W. (2002). International information seeking behaviours of South African exporters. South African Journal of Information Management, 4(3), Sept. Online: www.rauac.za/sajim Cox, D.F, Good, R.E. (1967). How to build a marketing information system. Harvard Business Review, May/June: 145-154. Ghoshal, S., Kim, S.K. (1986). Building effective competitive intelligence systems for competitive advantage. Sloan Management Review, 28(1): 49-58. Ghoshal, S., Wesney, D.E. (1991). Organizing competitor analysis systems. Strategic Management Journal, 12(1): 1-15. Gilad, B. (2000). Making the Case for Business Intelligence, Proceedings of the Society of Competitive Intelligence Professionals, Atlanta, Georgia, USA, April. Gilad, B., Gilad, T. (1985). A systems approach to business intelligence. Business Horizons, 28(5): 65-70.


225

Gilad, T., Gilad, B. (1986). Business intelligence - the quiet revolution. Sloan Management Review, 27(4): 53-60. Giitschleg, D. (1999). Deutsche Unternehmen im neuen Siidafrika, Berlin: Deutscher Industrie- und Handelstag. Guyton, W.J. (1962). A guide to gathering marketing intelligence. Industrial Marketing, March: 84-88. Herring, J. (1998). What is intelligence analysis? Competitive Intelligence Magazine, 1(2): 13-16. Kahaner, L. (1996). Competitive Intelligence. How to gather, analyse and use information to move your business to the top, Is* ed, Simon & Schuster: New York. NY. Montgomery, D.B., Weinberg, C.B. (1979). Toward strategic intelligence systems. Journal of Marketing, 43: 41-52. Mundorf, D. (1993). Bedeutung von Investitionen deutscher Industrieunternehmen fur die Wirtschaft Siidafrikas, Europaische Hochschulschriften, 1361:, Frankfurt am Main: Peter-Lang Verlag. Pearce, F.T. (1976). Business intelligence systems: the need, development and integration. Industrial Marketing Management. Pepper, J.E. (1999). Competitive Intelligence at Proctor and Gamble. Competitive Intelligence Review, 10(4): 4. Porter, M.E. (1980). Competitive Strategy: Techniques of Analyzing Industries and Competitors. The Free Press: New York NY. Prescott, J., Smith, D. (1989). The largest survey of leading edge competitor intelligence managers. Planning Review, May/June: 6. Sawka, K.A., Francis, D.B., Herring J.P. (1996). Evaluating business intelligence systems: How does your company rate? Competitive Intelligence Review, 10t'1 Anniversary Edition. SCIP (2001). Society for Competitive Intelligence Professionals, www.scip.org

Part III

Labour Market Adjustment, Foreign Direct Investment and Human Resource Development

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT: A Theoretical Analysis with Heterogeneous Labour T. GRIES1 and S. JUNGBLUT2 1 2

University of Paderborn, Germany Thomas.Gries9notes.uni-paderborn.de University of Paderborn, Germany jungblut9notes.uni-paderborn.de

9.1 INTRODUCTION High unemployment rates in South Africa's labour market of approximately one third of the labour force will be the most challenging problem in the next decade. Not only the level of unemployment is intolerable, also the structure is alarming. In the last two decades the gaps in unemployment rates and/or wages of unskilled and skilled labour has increased in almost all developing countries [OECD (1997), Gottschalk/Smeeding (1997), Murphy/Topel (1997)]. Further, as Whiteford/Seventer (2000) point out, in South Africa unemployment is also the major reason for poverty and for high inequality in income distribution.3 High unemployment rates may also become an obstacle for growth, as social unrest and political instability becomes more likely. Without a significant increase in employment, economic and political stability will be hard to obtain. As the problem of unemployment and low or even decreasing wages is likely to strike more unskilled labour [see e.g. Hofmeyr (2000)] most political concern should be devoted to this group of the labour force [see GEAR (1996)]. Both increasing trade and biased technological progress are blamed to cause inequality in labour markets. Empirically, this debate is still open. While OECD (1997) or Cline (1997 Ch.2) conclude that globalisation is of minor importance Wood (1998) summarises "...I review and reappraise the evidence, suggesting that most of it is, in fact, consistent with the hypothesis that the main cause of the rise in labour market inequalities is globalisation." [Wood (1998 p. 1468)]. For South Africa evidence seems to be mixed. Bell/Cattaneo (1997) or Edwards (1999) argue that a labour biased shift in trade affected employment in manufacturing industry negatively. Edwards (2000) not only 3

See also the other contributions in Leibbrandt/Nattrass (2000) "South Africa's changing income distribution in the 1990s"

230

T. GRIES and S. JUNGBLUT

analysed the impact of trade on the level of employment, but also breaks down the occupational employment impact. While in his findings the dominant source of employment change was technology, manufacturing is characterised by a skill bias in net trade reducing elementary employment. A number of approaches are used to model the effects of trade liberalisation on labour market performance.4 Especially unskilled labour does not always seem to realise a positive impact from trade liberalisation. The impact of globalisation on domestic labour markets goes well beyond its linkage with trade. A second channel is opened by factor mobility. Especially capital mobility and FDIs play a major role. There is hope that inflowing capital will create additional jobs and therefore will have positive employment effects. "Areas of economic activity previously closed to foreign enterprises are now being opened up and strong efforts are being made to woo TNCs." [Lall (1995 p.521)]. It seems also evident that FDIs will have positive effects on employment on total, but the structure of these effects is not so clear. "Despite the obvious importance of TNCs in creating employment opportunities in host countries the exact links between FDIs and labour markets are difficult to trace quantitatively" [Lall (1995 p.522)]. What happens if inflowing capital will only match with skilled labour, while unskilled labour is not or even negatively affected?"...the possibility must be considered that international labour market,...,operated in such a way as to match machinery and equipment with skill, not only with the least expensive labour that could be found." [Hanson II (1995 p. 156)]. Even if there are some contributions to the discussion of employment effects of capital mobility and FDIs [see e.g. Koizumi/Kopecky (1980), Lall (1995), or more recently Glass/Saggi (1999)]5 there is still little known about the structure effects on different labour market segments. It is not clear, if the important problem of increasing labour market inequality and large unemployment in the unskilled segment of the labour market will be positively affected by FDIs. The goal of this contribution is to obtain a better understanding of the unemployment effects of capital mobility on different segments of the labour market. While the Harris-Todaro model is the workhorse in development literature for analysing persistent unemployment problems, we suggest the labour market matching-approach as an interesting alternative for analysing the defined problem.6 In a labour market flow model the continuous separation of existing jobs and a growing population indicate the inflow of unemployed 4

See e.g. Wood (1994, 1995, 1997, 1998), and also chapter seven in this volume. For a general discussion see also Gilroy (1999). 6 A major problem concerning the analysis of unemployment in developing countries is a limited number of theoretical approaches. Fields (2000 p.5) mentioned: "There does not yet seem to be a labour market model that properly incorporates the main stylised facts." Therefore, we suggest the labour market flow approach as an additional tool for discussing the problem of persistent structural unemployment. 5

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT

231

persons into the labour market. On the other hand firms offer vacancies of newly created jobs as well as existing but presently vacant jobs. The number of vacancies offered to the market depends on the cost of employment as well as the costs of job creation or reemployment. The matching of the job profile and the workers skill and ability profile determines the outflow of unemployed workers out of the labour market. The sum of the separation rate, the population growth rate, and the job-matching rate gives the net change in unemployment. If the inflow and outflow rates are equal, labour market is in a stationary equilibrium, i.e. the labour market faces a flow equilibrium with persistent unemployment. In the model used to analyse the impact of FDIs on employment two segments of the labour market are distinguished, one for skilled and one for unskilled workers. For each segment the long term unemployment equilibrium is derived. Allowing for international capital mobility we analyse the effect of FDIs on relative factor prices, optimal factor allocation and the opportunity costs of vacancies in the different segments of the labour market. The main finding is that skilled labour will always gain from increasing FDIs while the effect on the unskilled is ambiguous. The ambiguous effect for unskilled is the result of a general positive effect of FDIs on aggregate employment and a negative reallocation affecting the unskilled. The negative effect can be reduced or even reversed if FDIs are complemented by policies like imports of foreign experts or additional human capital investments.

9.2 THE MODEL 9.2.1 Workers We consider an economy with a large number of households and identical firms. The aggregate labour endowment of households, L, is constant and there are two types of workers, skilled and unskilled. The unskilled workers, Lu, offer raw labour services while the skilled workers, Ls, offer human capital services. The aggregate distribution of both types of workers is constant. At any point in time workers of each type are either employed or unemployed and searching for a job. The number of employed and unemployed workers is denoted Nj and Uj respectively, with Uj=Lj,

j = u,s

(9.1)

9.2.2 Firms Firms demand capital and labour services to produce a homogenous good. The number of goods produced by a single, representative firm i is denoted X1.

232


The production function is a nested CES-function with raw labour services, £, and capital services, /C, as upper level inputs:

with flic = (1 — /?£). We suppose that the substitution parameter 7 is positive. Thus, the elasticity of substitution d = j ^ — is less than one and raw labour services and capital services are considered to be complementary inputs.7 Raw labour services are measured in efficiency units, L = \NU, where A, denotes a productivity parameter with constant growth rate A. Capital services K include human as well as real capital service and are produced according to a Leontieff technology with factor productivity

1C =

KK = K

(9.3)

With this assumption we introduce the hypotheses of complementary skills and modern real capital. The human capital input Hl is measured as the number of skilled workers times per capita human capital endowment h: H* = hNls Since the production function (9.2) is homogenous of degree one, aggregate output is given by

X = F(Nu,Ns,h,\): = [t hNs =

K-1K.

(9.4)

Given that 7 > 0 the basic assumption about the production technology is that technical progress is (unskilled) labour augmenting which in turn requires real as well as human capital services to become effective. 9.2.3 Factor Income and Accumulation Let Wj denote the wage rate per worker of type j ; r the net user cost of capital, and n redistributed profits. Then, labour income, YL , and capital income YK are given by YL = w N + w N

YK=J+rK 7

For empirical support and further discussion of this assumption see OECD (1996), p. 100.

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT

233

Factor accumulation equals income less consumption. We suppose that the accumulation of real capital, K = dK/dt is a constant fraction s of real capital income K = sYK,

(9.5)

and human capital accumulation, H = dH/dt , is financed by public expenditure. The educational spending is assumed to be a constant fraction r of mass or labour income: = hLs =

TYL

(9.6)

9.2.4 Labour Markets The adjustment dynamics of employment are determined by the search activities of workers and the job creation and reemployment activities of firms. The search activity of workers is measured by the number of unemployed in each segment of the labour market8, Uu and Us , while job creation and reemployment activities of firms is measured by the number of vacancies offered for each type of worker, Vu and Vs. Moreover, the number of successful job matches at any point in time, Mj, is considered to be a function of search activities and vacancies. Mj = Mj(Uj,Vj),

j = u,s

(9.7)

We assume that the matching function Mj(.) is linear homogenous. Thus, the probability to close a vacancy as well as the probability to find a job is a function of the ratio of Vj to Uj only. These probabilities are denoted M•^• = Mj(Uj/VJ,l)=:q{ej),

(9.8)

^

(9.9)

:p{0j)

where 6j = Vj/Uj denotes the tightness of labour market segment j = u,s. The partial derivatives satisfy dq(6j)/d0j < 0 and dp(6j)/d6j > 0. The matching function (9.7) describes the outflow of labour market j — u, s. The inflow of labour market j is given by the number of jobs which are separated at any point in time. For simplicity the separation rate Sj is assumed to be constant. Thus, the change of employment, JV,-, is 8

For simplicity, on-the-job search activities are not considered.

234

T. GRIES and S. JUNGBLUT Nj = Mj - <jjNj = Vjq(Oj) -

ajNj

The labour market is in a flow equilibrium, if inflow equals outflow: Nj = 0 & VjqiOj) = ajNj

(9.10)

9.2.5 Vacancies A vacancy is a newly created job or the reemployment of a presently vacant job offered to the market. The number of vacancies offered by firm i, Vj, is the control variable to adjust employment. Since firms are small and cannot individually influence the aggregate number of vacancies, 0j is taken as given at the firms' level. The creation of a new job as well as the adjustment for reemployment of an existing job absorbs resources. Let cVj denote the real value of resources necessary to offer an additional vacancy of type i. Then, reemployment expenditure of firm i in market j equals cVj Vj. The present value of profits then is

i, A,/C) - wuNt - wsNi - cVuV> - c . t ? - rK'jdt, where p denotes the firms discount rate. Since profit maximisation implies K = nhNs the maximisation problem is m&xNjVj 7rj := /0°° ePt{F(Ni, Nl, A, h) - wuNt - (ws + rnh)Ni - c ^ - ^.V* -

rK^dt,

subject to

for j = u, s. This problem can be solved by setting up the present value Hamiltonian function H(N^,Nl,V^,V^, fj,u, fis,t) with fij as the costate variables. In addition, let FJV, denote the partial derivative of F(.) with respect to Nj. Then, the Hamiltonian conditions are Q

=W]^

° = -eptc^

+ W(6i)> t

J = M>s'

\-FN-u ~ wu\ - Vuoo

If (9.11a) is differentiated with respect to time and the result is substituted for fij in (9.11b) and (9.11c), respectively, we arrive at FNu -wu-

cVuq{6u)-1 K + p - cVu/cVu - vju/0u\

FNus ~ K + ™h) - C^q^s)-1

= 0,

[CTS+P- CvJcVe - VS9S/6S\ = 0.

(9.12a) (9.12b)

In this form of the first order conditions Vj is used to denote the elasticity of q{Oj)~l with respect to 0j . Together, both conditions determine the number of vacancies supplied as a function of the workers marginal productivity, the wage rate (adjusted for capital costs) and the expenditures necessary to maintain or further adjust employment. Since F^. is identical for all firms and the production technology is linear homogenous in physical labour inputs, the conditions can be used to describe individual as well as aggregate search activities. 9.2.6 Job Creation and Reemployment Costs The cost to offer a vacancy is measured in units of the final good. In particular we assume that - at least in the long-run equilibrium—the cost is constant relative to output cVj=CjX.

j = u,s

(9.13)

Since the driving forces of output growth are human capital accumulation and technological progress equation (13) implies that the cost to supply a vacancy is positively related to these factors 10 . We further assume that the cost to supply a vacancy is higher for skilled workers than for unskilled workers, i.e. cs ^> cu.

The equations described so far are not sufficient to determine the behaviour of wages endogenously. One hypothesis to determine factor payments extensively discussed in the context of search models is to describe wages as the outcome of a bargaining process between firms and workers 11 Although we think that this approach is reasonable, it would nevertheless substantially complicate 9

See Michel (1982) for a discussion of this type of transversality condition in infinite horizon control problems. 10 If Cj were not constant in a growing economy, the costs of vacancies would be asymptotically zero or infinte relative to production which we think would be a counterfactual assumption. n See e.g. Mortensen (1978), Diamond/Maskin (1979), Diamond (1982), Pissarides (1985, 1990).

236


the structure of the model. To approximate this wage hypothesis and keep the wage determination simple we assume that the wage rate is proportional to the marginal productivity of labour Wj = uFN.

0 < w < 1,

(9.14)

where w may be understood as the result of a bargaining process not modelled explicitly.

9.3 STEADY-STATE SOLUTION 9.3.1 Equilibrium Conditions The economy is in steady-state if both labour markets are in a flow equilibrium (Nj = Vj = 0) and the growth rate of real and human capital endowment equal the growth rate of technological progress (K = h = A). To analyse the economic implications of these long-run equilibrium conditions we first use equations (9.1), (9.9) and condition (9.10) to express equilibrium employment as a function of labour market tightness 6j = Vj/Uf j = u,s

(9.15)

It is straightforward to show that dNj/dOj > 0, d2Ni/d62j < 0, and dUj/dOj < 0, d2Uj/d9"j > 0. Thus, the steady state level of employment for workers of type j is positively related to the equilibrium level of search activity and labour market tightness 0j, respectively. Therefore, the labour market effects of the parameters of the model can be analysed by looking at their impact on Qj, keeping in mind that the higher 6j the higher the equilibrium level of employment of workers of type j . To derive the equilibrium values for 6U and 9S we first make use of the accumulation conditions (5a) and (6). In any stationary equilibrium these conditions imply

Taking the definition of YL and YK into account, this condition can be equivalently expressed as

with

Thus, the function 4>(6U,9S,...) describes an inverse relationship between 6U and #,:

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT _ ~

d<s>/aeu d/aes ^

237

n u

Which of the possible search combinations of (9.16) will finally result depends on the first order conditions (9.12a) and (9.12b). Since in any stationary equilibrium 0j = 0, cVj = X = A, and n-A=f-

x

-

.

aa+p{fls),

these conditions can be expressed as 12

(9.17) and c,es

0=1-T±- rK-

(9.18)

8,

Fig. 9.1. Equilibrium Search Activities. It is straightforward to show that for any given r

Equations (9.16), (9.17) and (9.18) simultaneously determine the long-run equilibrium values for 6a, 6U and r (see Figure 8.1). 12

1-

To derive conditions (9.17) and (9.18) we made further use of the fact that "

N^ _

FNaNa

_

„ r x

ip

238


9.3.2 Economics of the Steady State The level of search activities as represented by equation (9.16) is mainly a function of u> . This variable indicates the share of labour income. Obviously, &(&u, @s, • • •) will shift outwards in the 6U — 6S plane if u> decreases. This reaction is straightforward because a lower labour share increases the incentives to search for additional workers. However, equation (9.16) also implies that for any given level of aggregate search activity there also exist an inverse relationship between search activities for different types of workers and thus an inverse relationship between the employment levels of skilled and unskilled. This inverse relationship results from the long run-resource constraint of the economy - the accumulation of different types of capital. Equation (9.16) shows that for any given employment level of unskilled workers, NU(9U) , the employment level of skilled workers, N(9S) , will be the higher the higher (S/T)/K. Thus, the higher the accumulation ratio (S/T relative to the input ratio K the higher the search activity and employment level for skilled workers. The first order conditions (9.17) and (9.18) finally determine which of the feasible search combinations implied by (9.16) will result in equilibrium. A closer inspection of these conditions shows that the equilibrium levels are basically functions of the relative productivity of each type of worker. In particular, it is immediately obvious from equation (9.18) that the level of employment of skilled workers is positively related to the rate of technological progress A . Thus, the unskilled-labor augmenting property of technological advances immediately translates into higher search activities for the skilled, and - due to the long-run resource constraint (9.16) - a higher level of unemployment among the unskilled.

9.4 EMPLOYMENT EFFECTS OF FDIs 9.4.1 Pure Effects of Inflowing FDIs Given the importance of the long-run resource (accumulation) constraint of the economy it is straightforward to ask about the labour market impact of foreign direct investments (FDIs). We assume that FDIs are driven by interest arbitrage. That is, in this approach we focus on a macro-oriented comparative cost view at the supply side of the firms (Ruffin (1984)). Even if most summarising literature (see e.g. Caves (1982) or Borner (1983,1985) or Gilroy (1993)) discuss the various arguments against a strict application of the capital arbitrage approach, there is evidence that from the long-run macro perspective capital arbitrage still seems an important determinant of international direct investment (Haynes (1988)). Therefore, for the analyses in this model international interest arbitrage seems a suitable approach. To analyse this question we will assume that in the initial situation the country

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT 239 is relatively scarce in physical capital, resulting in a relatively high real rate of interest r as compared to the world market price f. If the country opens for FDIs an immediate consequence of the additional access to physical capital will be that the resource constraint represented by the accumulation function (9.5) does no longer bind. Consequently, equation (9.16) does not restrict search activities in labour markets. Instead, the first order conditions (9-17) and (9.18) now simultaneously determine the tightness of labour markets 9U and 6S for the world market interest rate f. M^,e,,f,...) = o,

(9.19)

&(0 u ,0 s ,f,...) = O,

(9.20)

To understand the impact of a reduction of r on the search activities for both types of labour we combine equations (f)u{.) = 0 and s(.) = 0 to derive the open economy equivalent of the aggregate resource constraint (9.16): n

_ -, _

_ cueu[au

=

cf>(eu,es,f,...),

The derivatives of this equation satisfy 19

^

0

Thus, similar to the closed economy we obtain a resource constraint which implies an inverse relationship between search activities in different segments of the labour market. Moreover, the negative derivative of 6S with respect to f implies that aggregate search activity is inversely related to f. The outward shift of the resource constraint ip(.) = 0 (Figure 9.2) induced by a decrease in f indicates that the economy will be able to reach a higher level of economic activity after opening for FDIs. The impact on economic activity then translates into a higher aggregate search activity for labour services. This effect is due to the fact that the real interest rate is part of the opportunity cost of firms when investing into search expenditures instead of real capital. The additional supply of physical capital from FDIs will reduce these opportunity costs and thus - other things being equal - makes it more attractive to employ additional workers. In addition to their impact on aggregate search activities FDIs will, however, also have a disaggregated effect. The additional supply of physical capital increases the demand for human capital and thus the incentives for firms to search for the skilled. This effect is captured by equation (9.18) and the derivative

240

T. GRIES and S. JUNGBLUT ' dB/d9e

dfi.

10 years old What % of products/services in the GROUP is due to innovations in last 3 years? How many new jobs have been created in SA by technological innovations in a) 1997 b) 1998? c) 1999? How many jobs were terminated in SA by technological innovations in a) 1997? b)1998? c)1999? Are skills in SA appropriate for technology used? (Y/N) Amount spent on foreign licences and agreements in SA in ($) in: a) 1997 b) 1998 c) 1999 How many patents did your group own in a) 1997 b) 1998 c) 1999 % Of sales generated by SA company due to E-Commerce in a) 1997 b)1998 c)1999

289

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11.

12.

% Of sales generated by GROUP due to E-Commerce in a) 1997 b) 1998 c) 1999 Are IT & Communications Technical Business Support Services Adequate in SA? (Y/N)

SEC TION 4: TRAINING QUESTIONNAIRE 1.

2.

3. 4. 5. 6. 7. 8. 9.

10.

What % of your SA labour force is a) Low-skilled (< Std 8)? b) Medium skilled (< diploma)? c) Highly-skilled (degree)? Amount spent in Rands by SA company on training for employees in a) 1997 b) 1998 c) 1999 Do you send employees to Germany for training? (Y/N) Do you provide training for suppliers/clients? (Y/N) Are training & skills levels in SA adequate for your purposes? (Y/N) Does crime impact negatively on your company's sales? (Y/N) Is corruption & theft a significant problem in your company? What is the average monthly wage in Rands of your company in 1999? Does your organization experience problems in maintaining technical expertise? (Y/N) What does your organization do to retain good employees?

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SEC TION 5: BUSINESS ENVIRONMEN r QUESTIONNAIRE 1.

2. 3. 4.

5.

6.

7.

8.

Please list the major constraints on your business' profitability in SA a) b) c) d) e) How many competitors do you face inSA? How many new competitors entered the market in the last year? How does your company finance investment? % From a) Retained earning? (%) b) Parent company? (%) c) Loans in SA? (%) d) Loans in Germany? (%) e) Overdraft? (%) 0 Equity? (%) What is your expectation of the level of the following indicators in 3 years' time (up/down/same) a) Inflation? b) Rand: $ exchange rate? c) level of import tariffs? d) Company tax rates? e) Crime? What amount did your company spend in SA on marketing in (R) a)1997 b)1998 c)1999 What was the value of your exports from SA (in $) in a) 1997? b) 1998? c) 1999? What are the major destinations of your exports from SA? a) b) c) d)

291

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SEC ITON6: NETWORKS 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

What value of your inputs are sourced from SA small enterprises in a)1998? b)1999? Do you have a procurement policy that favours small and micro enterprises? (Y/N) Have you been involved in technology transfer to suppliers and clients in SA in 1999? (Y/N) Have you brought SA companies in contact with other German companies in 1999? (Y/N) Have you outsourced functions of your company in SA over the past 3 years? (Y/N) Have you restructured or reengineered your company in SA over the past 3 years? (Y/N) Does your company office act as services centre for other African countries? (Y/N) How much has your company spent in SA on social responsibilities in a)1998? b)1999? Are your products/services in conformity with International Standards Organization (ISO) requirements? Are your company's plants and offices located in a business park? (Y/N) How significant a constraint is the current transport and logistical services in SA on your organization? Big constraint (5) Medium Constraint (4) Average constraint (3) Small Constraint (2) No constraint (1)

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Section 7: Competitive Intelligence Prior to completing the section, familiarise yourself with the following definitions of Competitive Intelligence as they form the basis of this section. Competitive Intelligence is: Timely and fact-based information on which management may rely in decision making and strategy development. CI may involve an industry analysis, which means understanding all the participants in an industry; competitive analysis, which is understanding the strengths and weaknesses of competitors; or benchmarking, which is the analysis of individual business processes and competitors. (Society of Competitive Intelligence Professionals) Competitive Intelligence is: Information which describes the competitiveness of a firm; understanding the competitive arena, predicting competitor's moves, customers moves, government moves and so forth (Gilad, 1994). Do your organization make use of competitive intelligence methods to gain information regarding your competitors? Yes No a) If yes, does your company have an organized unit/department - doing CI? Yes No b) If no, is CI integrated throughout the organization? Yes No If yes (question 1), which department/division is principally responsible for CI. Marketing Strategy/planning Corporate R+D Distribution CI unit Finance Manufacturing Other(indicate) How long has the unit/dept been in practice?

years

How many employees in your firm have a part-time or full-time CI responsibility? part time full time 6. How much access do CI personnel have to the president and/or CEO of the firm? Select one. 0 No access 1 Annual 2 Infrequent 3 Monthly 4 Weekly 5 Daily

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CI Gathering Intelligence can be gathered through various sources. Please use the following scale to indicate the importance of the following sources and how frequently you use it. For importance, please use the following scale: 0=Unimportant, l=Neutral, 2=lmportant, 3=Somewhat important, 4=Very Important For frequency, please use the following scale: 0=notused, l=Annual, 2=Monthly, 3=Weekly, 4=Daily

Information Source Archival (articles, reports, etc.) Associations Competitor's personnel Consultants (other than industry experts) Customers (foreign and domestic) Focus groups Government representatives in your country Government representatives in another country Internet Journalists Peers in other departments/divisions Peers in your department/division Subordinates Superiors (bosses) Suppliers Other

Frequency

Importance

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Dissemination (Distribution) The following question examines how you disseminate information. You are asked to indicate how frequently you use the specified dissemination methods and how important are they? For frequently, please enter a number between 0 and 4 using the following scale: 0=not used, 1= Annual, 2=Monthly, 3=Weekly, 4=Daily For importance, please use the following scale: 0=Unimportant, l=Neutral, 2=lmportant, 3=Somewhat important, 4=Very Important

Dissemination Method Customized reports Personal communication Memo Presentation Newsletter Intelligence seminar/meeting Intranet Retreat E-mail Bulletin boards Computer databases Fax Files

Frequency

Importance

Management and Organization The intelligence process involves planning the study, collecting and analyzing the information, disseminating and evaluating the entire project. When doing an intelligence project, how much time do you spend on each of these activities? Place the percentage of competitive intelligence time you spend on each activity. Note the column should total at 100% Intelligence activity Planning for the CI study Collecting information Analyzing the information Disseminating the results Evaluating the results of the CI study

% of your time

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Constraints Please assess the extent to which each problem currently hampers your CI efforts or prevents you from doing competitive intelligence 0=Not a problem, l=Somewhat a problem, 2=Medium Problem, 3=Major problem Problem area

Extent of problem

Top management commitment to the CI effort Legal issues Ethical issues Integrating CI in the organization Getting people in the organization to share information Number of CI personnel Internal politics Getting decision makers to use CI output Interaction with senior management Credibility among managers for CI Getting feedback from clients Budget Training Counter-intelligence Other

THANK YOU FOR YOUR CO-OPERATION IN COMPLETING THIS QUESTIONNAIRE.

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297

Questionnaire for German Enterprises in the Republic of South Africa

When did your company start operating in South Africa?

01

Does your company operate as a different type in the host country in comparison to its home country? yes, 02 no 03

3. How many employees do you employ: in South Africa 01 in Germany 02 in the world ?03 4. How many business branches to you hold in: in South Africa 01 in Germany 02 in the world ?03 5. In which sector of tions possible!) Primary industry Secondary industry Tertiary industry

the economy does your company operate? (More than one op01 02 03

More precisely: Machinery and supplying industry Clothes and textile Electronics Chemistry Paper industry Construction Banking Refining Public transportation

01 02 03 04 05 06 07 08 09

Consumer goods industry 10 Shipping 11 12 Tourism 13 Food and nutrition Office supply 14 Insurances 15 16 Information technology 17 Consulting business

6. To how many /which countries do you export directly from S.A.? (Number) West Europe 1 Asia 3 North America 5 Australia 7 South America 2 Arab 4 East Europe 6 Africa 8 None 9

01

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7. From which countries do S.A. affiliate import on a regular basis? West Europe 1 Asia 2 North America 3 Australia 4 South America 5 Arab 6 East Europe 7 Africa 8 None 9

8. Which corporate comparative advantages is offered by being in South Africa? 1 Management Relative inexpensive labour force Marketing 2 Political stability Research and Development Tax advantages 3 Access to financial means 4 Location advantages Technology Sound education level 5 High labour motivation Protection of intangible goods 6

7 8 9 10 11 12

9. Which institutions gave assistance by entering the host market? German-South African Chamber of Commerce 01 German Development Society (DEG) 02 German embassy 03 a consulting company 04 the parent company's personnel 05 Miscellaneous 06

10. In which activities do you engage the most? Licensing (1) Export (2) Foreign Direct Investments (3)

11. How would you specify your Investments? Portfolio-Investment (1) FDIs to secure location Re-Investments (2) Investments for expansion

(2) (3)

12. How would you classify your investments in the host country? operative 01 tactical 02 strategic 03 13. In which timeframe do you plan to engage in your next investments? in 2000 (1) in 2001 (2) in 5 years (3) in 10 years (4) 14. How does privatization influence your decision for investments in South Africa? Increase of investments 01 No influence 02 Decrease in investments 03

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15. How will your company finance your planned investments? from the corporation (internal sources) through debt financing in South Africa through equity and credit financing from Germany through government subsidies through other financial means Total investment

299

% % % % _% 100%

16. Which of the following variables in the host country have a crucial importance (Imp) to you? High Imp Low Imp No Imp Qualification of work force Wage rate and power of unions Unrest in the country Political climate Spare federal investment incentives of host country Spare federal investment incentives of home country Low and insufficient infrastructure Foreign culture and value system Foreign currencies and expatriation restrictions Other reasons:

17. Which growth potential do you foresee for the next 5 years in South Africa? high potential 01 medium potential 02 low potential 03 18. How do you evaluate the current economic situation of your company in South Africa? excellent 01 stable 02 constant 03 risky 04 19. How do you evaluate the federal assistance of FDIs from Germany in comparison to the financial assistance in the host country and other industrial nations? excellent 01 sound 02 satisfactory 03 limited 04 20. In which of the following activities is your company involved? Licensing 01 irregular export 03 Export via distributor 05 Export 02 local production 04 product differentiation 06 Foreign direct investment 07

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21. Which of the following strategy describes your current corporate company strategy? cost minimisation 05 generate price advantages 01 02 enhancing marketing 06 price increase company expansion 03 07 introduction of new products 04 increase in import 08 increase in export 22. How do you evaluate the competition with other Multinational Enterprises in South Africa? very intense (1) high (2) medium (3) low (4) weak (5) 23. Is your company listed on the stock market in Johannesburg (JSE)? yes, since (1) no (2) expected in

(3)

24. In which sectors do you see further potential for economic growth in South Africa? Airports Telecommunication Public transportation Tourism Computer industry Pharmaceutical industry Health care Security services Machinery and equipment Banking Insurances Electronic industry Mining Manufacturing others 25. In which form is your company linked with the location of South Africa? Licensing to companies in South Africa Co-production with companies in South Africa (Joint Ventures) other forms of co-operations without capital investment Acquisition of stocks from South African companies Establishment of own production plants in South Africa other economic involvements:

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301

South African (SA)-European Union(EU) Free Trade Agreement 1.

Do you know the content of the SA-EU Free trade agreement? yes (1) only partial (2) no (3)

2.

Which co-operation agreement between the EU and South Africa do you figure to be the most important? Development co-operation (1) Trade co-operation (2) Economic co-operation (3)

3.

How much increase in turnover do you expect due to the EU-SA FTA? >50 01 >25% 02 10% 03 >5% 04 >1% 05

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