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Improving the Business and Investment Climate in Africa – Why and How?

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Improving the Business and Investment Climate in Africa – Why and How?

Improving the Business and Investment Climate in Africa – Why and How?

The ‘cost of capital’ refers to the rate of return required by lenders of capital or investors, in order to incentivise them to provide capital to business ventures. Developing economies are characterised by high costs of capital and limited sources of investment funds. This acts as one constraint on the potential growth rates of these economies, and so the attractiveness of these economies to foreign investors should be an important consideration of policy makers[i]. When governments take actions and implement schemes to actively encourage investment, this is referred to as investment promotion and the state entities established to promote investment are referred to as investment promotion agencies (IPAs).

At the regional economic community (REC) level, the community itself cannot directly make policy for its members, but protocols, which provide frameworks for recommended policies, can be negotiated and adopted by the REC member states. At the time of writing, negotiations are under way for an investment protocol for the African Continental Free Trade Area (AfCFTA). This is against a backdrop of general investor optimism about the potential of the AfCFTA for creating trade and investment opportunities within Africa[ii]. At the same time, certain African regional groupings have in place their own investment promotion drives, for example:

  • The ECOWAS ‘improved business and investment climate in West Africa’ initiative[iii]. This investment facilitation initiative aims to identify barriers to investment, implement reforms, monitor and evaluate and showcase the positive results of reforms to the private sector.

  • The EAC also promotes cooperation among member states in investment and industrial policy, and has an active program for reforming policies and state interventions to make their economies investor and market friendly[iv].

By contrast, SADC has no defined, up to date coordinated investment facilitation programme. Although each member state has its own investment promotion agency, there is no programme at the regional economic community (REC) level for reforming policies, making economies and markets investor friendly, and showcasing success stories to investors.

The ASEAN region of emerging industrialising East Asian nations is often used as a benchmark for developing nations hoping to follow a similar industrialising path to development. The ASEAN has incorporated investment facilitation into its agreements for more than a decade but implementation is left to individual countries. This has led to calls for a more active policy programme to be put into place[v].

The former communist countries, or ‘transition’ economies, represent countries that formerly had repressive and centrally controlled economies, in common with certain African countries such as Tanzania, Angola and Mozambique. These countries, together, do not have a regional or economic grouping to which they currently belong, but there is formal evidence that their efforts to reform their economies to promote ‘economic freedom’ have greatly assisted them in attracting investment[vi].

What should form the goals of African countries and the AfCFTA’s framework in terms of facilitating and maximising investment flows to our shores? ‘Business friendliness’, or the extent to which the regulatory environment and public governance favours or prejudices business activity, is an important focus in this respect. For comparative purposes, business friendliness is a key variable of interest when analysing the investment performance of developing countries. By using the World Bank’s ‘ease of doing business’ score (and some author-calculated permutations of it and its constituent indicators), one can compare business friendliness between the Africa aggregate and three other global regions of interest; as well as across the five main sub-regions within Africa.

The Africa aggregate is firstly compared with a group of countries referred to as the ‘East Asian Industrialising’ (EAI) group, the transition economies and the developed world[vii]. The ease of doing business score is compared with the foreign direct investment (FDI) proportion out of GDP for the period 2008 to 2019 (Table 1).

Table 1: Comparing FDI inflows with ease of doing business score – selected global regions (2008-2019)

 

Africa

EAI

Transition

Developed

Ease of doing business score (0 = lowest performance to 100 = best performance) (average over entire period)

51.22

61.98

74.02

76.82

Foreign direct investment, net inflows (% of GDP) (average over entire period)

3.6%

4.9%

3.9%

14.4%

Source: Author’s calculations using World Bank data

An interesting pattern is seen in Table 1, with the EAI leading both Africa and the transition economies in FDI performance, but with the transition economies leading the non-developed regions in terms of business friendliness. This underscores that business friendliness is but one determinant in attracting investment, others include infrastructure, public finances, property rights, political stability, voice and accountability, rule of law, control of corruption and governance[viii]. Undoubtedly, aspects of various of the preceding will play a role in determining the level of business friendliness, but the indices of business friendliness that are quantifiable are the most obvious choices when undertaking an analysis of this sort.

Within Africa, a comparison across the main African sub regions: Central, East, North, Southern and West offers insights to relative levels of investment and business friendliness performance. The indicators used and the date range are a little different to the data in the previous table but offer similar insights (Table 2).

Table 2: Comparing FDI inflows with ease of doing business proxy – African sub-regions (2016-2019)

 

Central Africa

East Africa

North Africa

Southern Africa

West Africa

Change – inverse business ease proxy (change over entire period)

-33.3%

-21.3%

-22.4%

-6.6%

-38.2%

Average – FDI inflows as a percentage of GDP (average over entire period)

4.9%

4.2%

2.8%

4.0%

5.9%

Source: Author’s calculations using World Bank data

Of the African regions, West Africa has made the most progress in improving its business friendliness and in attracting FDI, by reducing impediments to business ease. The pattern within Africa is clear – the countries that have done the most to liberalise their business environment have also attracted the most FDI, albeit with North Africa’s data impacted by the outlier of Libya’s internal conflict.

The policy recommendations for African governments and supra-national entities that can be drawn out are:

  • Regulation and governance are very important. Foreign investors and multi-national corporations (MNCs) have choices when it comes to investment location (except where there is a unique natural resource endowment such as South Africa’s platinum metal groups reserves). Excessive compliance requirements, over regulation and inefficient governance processes all discourage investment.

  • FDI is important for growth performance. Small developing economies lack the ability to accumulate their own capital at the rate, or price, required for investment to be an effective driver of growth. Foreign sources are important, not just for funding but also for technology and skills transfer. Investment promotion and facilitation, both at the national and supra-national/regional level are important. Continental groupings such as the AfCFTA can play an important role in defining investment protocols, coordinating investment promotion and facilitation, and holding member states to account for participation and enforcement.

  • Business friendliness is not the only determinant of investment attractiveness, other factors such as infrastructure, trade openness, financial and technological development and overall stability are also important.

The countries of Africa should emulate West Africa and its REC, ECOWAS, which has put in place an initiative known as the ‘improved business and investment climate in West Africa’. Of all the regions of Africa, West Africa has made the most progress recently in improving its business environment and in attracting investment. Furthermore, the AfCFTA could look to ECOWAS’ approach in framing its own investment facilitation strategy; and AfCFTA could also learn from the ASEAN grouping in terms of the importance of having investment facilitation provisions incorporated into its agreements. As Africa moves away from commodity-dependence and towards a more diversified, manufacturing base, a fresh and innovative approach to investment facilitation will be needed.


[i] Healthy FDI inflows are positively associated with GDP growth both across global regions and across African sub-regions. Refer to the tralac trade brief by the author: Stuart, J. 2021. Investment, Growth and Business-Friendliness- Some Lessons for Africa. tralac Trade Brief: Stellenbosch

[ii] Erasmus, G. 2021. An investment protocol for the AfCTA. tralac blog accessed at:

https://www.tralac.org/blog/article/15152-an-investment-protocol-for-the-afcfta.html

[iii] ECOWAS. 2020. ECOWAS launches improved business and investment climate in West Africa website. Press release accessed at:

https://www.ecowas.int/ecowas-launches-improved-business-investment-climate-in-west-africa-project-website/

[iv] EAC. 2021. Investment promotion and private sector development. Online content accessed at:

https://www.eac.int/investment

[v] Yean, T. S. 2021. Facilitating Investment in Southeast Asia: ASEAN and WTO Initiatives. Accessed at:

https://www.iseas.edu.sg/articles-commentaries/iseas-perspective/2021-64-facilitating-investment-in-southeast-asia-asean-and-wto-initiatives-by-tham-siew-yean/

[vi] Kenisarin, M., & Andrews-Speed, P. (2008). Foreign direct investment in countries of the former Soviet Union: Relationship to governance, economic freedom and corruption perception. Communist and Post-Communist Studies, 41(3), 301-316. Accessed at:

https://www.jstor.org/stable/48609763

[vii] For a full breakdown of these country groupings, please refer to the tralac trade brief by the author: Stuart, J. 2021. Investment, Growth and Business-Friendliness- Some Lessons for Africa. tralac Trade Brief: Stellenbosch

[viii] Chaib, B. and Siham, M., 2014. The impact of institutional quality in attracting foreign direct investment in Algeria. Topics in Middle Eastern and African Economies, 16(2), pp.142-163. Accessed at:

http://meea.sites.luc.edu/volume16/pdfs/Chaib-Siham.pdf

About the Author(s)

John Stuart

John Stuart

John Stuart is an economist and policy analyst with special interests in trade, economic integration, data visualisation and economic modelling. He began his career in academia at Rhodes University and later the University of Cape Town, after which he entered private consulting first with AFReC (Pty) Ltd and subsequently with PBS (Pty) Ltd. Besides economics research and teaching, he has experience in project management, general management, public sector performance management, systems analysis and entrepreneurship. He holds an M. Com degree in Economics from the University of Natal (Durban).

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