Challenges in the Era of Globalization - iaabd

Proceedings of the 12th Annual Conference © 2011 IAABD
of its volatile nature especially compared to FDI. Also FPI may constrain the policy options available to
domestic governments (see Grabel, 1996). Though the quantum of FDI outstrips FPI on the continent, FPI
is increasingly becoming important to African countries. Adjasi et. al (2010) examine the topical issue of
FDI and economic growth in Africa. Their paper focuses on whether FDI has contributed to economic
growth on the continent. On its own, they find that FDI has no significant impact on growth. However,
they find that FDI when interacted with financial markets significantly influences economic growth. Their
paper however, does not examine the role of FPI in the determination of economic growth in Africa. Also
given the increasing importance of FPI, it is important to examine its effect on economic growth.
However, there is a dearth of literature as to the role of FPI in the determination of economic growth in
Africa.
Therefore in this paper, we examine whether FPI on its own significantly influences economic growth on
the continent. In the absence of a significant FPI growth impact, we examine if financial markets are able
to transform the insignificant effect of FPI into growth. This is because FPI interacts with the real
economy via the stock market. The rest of the paper is structured as follows: Section 2 examines the
extant literature on FPI and economic growth, Section 3 details the methodology employed in the
empirical analysis, in Section 4 we present the results from our empirical estimations and finally in
Section 5 we conclude the paper and draw policy implications.
Literature Review
Immediately after independence, there were great hopes and predictions of massive economic
transformations that will lift Africans out of poverty. Enke (1963) ranked Africa’s growth potential ahead
of East Asia’s, and Kamarck (1967), the Chief Economist of the World Bank, listed seven African
countries that had the potential to reach or surpass a 7 per cent annual growth rate (in Mobolaji, 2009).
These hopes and predictions had been elusive for several decades. Several growth regressions seeking to
explain growth on the continent have appeared in the literature. These studies in the main sought to
explain the growth tragedy of Africa and what was driving economic growth. This underperformance of
Africa compared to the rest of the World has been referred to in the growth literature as the African
dummy. Barro (1991) finds that there appears to be adverse effects on growth from being in sub-Sahara
Africa. Though the growth prospects of the continent have improved in recent times, empirical
researchers are still exploring the ‘holy grail’ as to what explains growth on the continent.
Advocates of foreign portfolio investment believe that it can lead to the development of domestic stock
markets and therefore stimulate economic growth through its effect on the stock market. It is believed that
FPI gives an upward thrust to domestic stock prices which in turn increases the P/E ratio of listed
companies and therefore reduces their cost of capital (see Pal, 2006). This reduced cost of capital for
firms can stimulate more investments by companies since the ‘hurdle rate’ for project appraisal is
reduced. Increased investment and productivity by firms should lead to economic expansion. Also given
that foreign portfolio investors contribute to making the secondary markets more active, it presupposes
that this should also lead to more activity in the primary market. This is because more active secondary
markets make investors more comfortable to invest in primary market issues since it will be easier to
liquidate their investments if they need to. An active primary market means that firms can easily raise
funds to finance investment projects. The beneficial effects of FPI are crucially dependent upon the
assumptions that well functioning stock markets promote economic development and that international
portfolio investors are guided by economic fundamentals (Pal,2006).
Some recent studies report positive effects of capital flows, namely FDI and FPI, on macroeconomic
indicators (Borzenstein et al. 1998; Bekaert and Harvey, 1998, 2000; in Durham, 2003). However, the
evidence that private capital flows stimulate growth is inconclusive. Pal (2006) shows that the mainstream
argument that the entry of foreign portfolio investors will boost a country's stock market and consequently
the economy, does not seem be working in India. Durham (2003) does not find a statistically significant
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