The effect of Foreign Direct Investment, Foreign Aid and ... - IJIR

Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in

The effect of Foreign Direct Investment, Foreign Aid and Domestic Investment on Economic Growth: Evidence from Somalia Abdiaziz Ahmed Ibrahim1 & Abdulkadir Mohamud Dahie2 1

2

Lecturer at University of Somalia (UNISO) Graduate student, Master in Development Study at Kampala University

Abstract: This paper analyzed the effects of foreign direct investment, foreign aid, and domestic investment on the economic growth in Somalia. The study used annual data on a group of 55 observations 1970-2014. The regression analysis of the ordinary least square (OLS) is the estimation technique that is being employed in this study to determine the relationship between independent variables and dependent variable. The study found strong evidence of positive impact of foreign direct investment, foreign aid and domestic investment on economic growth. The paper concludes with explaining the results and suggesting some policy recommendations. Keywords: Foreign Direct Investment, Foreign Aid, Domestic Investment, Economic growth, Somalia.

1. INTRODUCTION In the past decades, foreign direct investment (FDI) by transnational corporations (TNCs) has become the prime source of external financing for developing countries.( Görg and Strobl, 2001). FDI can accelerate growth in the ways of generating employment in the host countries, fulfilling saving gap and huge investment demand and sharing knowledge and management skills through backward and forward linkage in the host countries (Frenkel, 2004) Foreign Direct Investment (FDI) affects economic growth of developing countries positively through transfer of capital, know-how, and technology. It increases activity not only in FDI beneficiary firms. The effect can spread to other firms in the country and sectors through technology spillover, human and capital formation and increasing competition, thus raising productivity for the whole economy (A., 2011) According to (Mamo, 2008) theories of FDI can be split into two groups; Micro

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level determinates of FDI and Macro level determinants of FDI. The micro level theories of determinates of FDI try product The Macro levels of determinants of FDI clarify on the host countries situations that to provide answer for the question why multinationals companies (MNCs) prefer opening businesses in foreign countries rather than exporting or licensing their determine the inflow of FDI. In Sub-Saharan Africa as a whole, total inward FDI stock has increased from $29.8 billion in 1980 to $317.2 billion in 2009, a comparatively smaller increase of ten-fold. This indicates that the region has not been as successful at attracting FDI as other parts of the developing world. Nevertheless, FDI has become an important part of the discourse on development in Africa. The New Partnership for Africa’s Development (NEPAD), a program set up by a group of heads-of-state from across the continent in 2001, remarks that in order to “achieve the estimated 7 per cent annual growth rate needed to meet the IDGs (International Development Goals) - particularly, the goal of reducing by half the proportion of Africans living in poverty by the year 2015 - Africa needs to fill an annual resource gap of 12 per cent of its GDP, or US $64 billion” (UNCTAD, 2014). With increased stability, foreign direct investment in Somalia is expected to grow in the coming years, yet current levels remain low, with USD 107 million inflows in 2013. The Somali government views foreign investment as a key component of rebuilding the economy, and actively encourages new investors. They have released multiple statements to this effect and hosted conferences to promote Somalia as an attractive investment opportunity. For example, the government co-hosted the Somalia Trade and Investment Event with the UK Department for International Development (DfID) in May 2013 and another conference in Dubai in May 2014 with the

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Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in Dubai Chamber 2014).

of

Commerce”

(UNCTAD,

Relatively, there is extremely little published research Foreign directs investment (FDI) and its impact on economic growth in Somalia. Therefore, this study we will focuses on the impact of FDI on economic growth in Somalia. In terms of a macroeconomicvariable, inorder to explore investment opportunities exists in Somalia. Accordingly the main objectives are: 1) To illustrate the relationship between foreign aid and economic growth of Somalia. 2) To demonstrate the relationship between domestic investment and economic growth of Somalia. 3) To describe the effect of foreign direct investment on economic growth

2. LITERATURE REVIEW This section highlights review articles about related empirical studies of foreign direct investment, foreign aid, and domestic investment and their effect on economic growth; those were established in many different contexts in the world. After reviewing these article most of the studies found positive relation relationship between the variables. This study investigated the effect of foreign direct investing on economic development of post Comecon transition economy countries. The study used neoclassical growth theory model to analyze the effects of FDI on economic growth. The results of the study had showed that FDI had significant influence on economic growth of host countries (Leonid Melnvk Oleksandr Kubatko, 2014). The aim of this paper is to investigate the influence of foreign direct investment (FDI)on economic growth in Southern Asia for the period 1977-2009, The study applied the random effects model, the Im, Pesaran and Shin (2003) unit root test to show the variables are stationary in level.The result showed that foreign direct investment (FDI) has positiveand significant effect on economic growth and variables such as human capital,economic infrastructure and capital formation have positive effect on gross domesticproduct (GDP). while, population, technology gap and inflation have negative effect onthe economic growth(Behname, 2012).


The purpose of this paper is to investigate the longrun relationship between foreign aid, foreign direct investment andeconomic growth in 36Sub-Saharan Africa countries over the period 1980-2007. The study used dynamicpanel data of mean group (MG), pooled mean group estimator (PMG), and dynamic fixed effect (DFE) proposedby Pesaran et al. (1999),the study foundstrong evidence of positive impact of foreign aid and foreign direct investmenton economic growth. However, the effect of foreign aid on growth in SSA is low(Njoupouognigni, 2010). The main objective of this paper is to determine the relationship between foreign direct investment, exchange rate and gross domestic product. The study used time series data; data for the study were collected from CBN Statistical Bulletin from 2008 to 2013. Pearson Correlation was used to test the hypothesis with aids of SPSS version 20.0. Thefindings of the study revealed that there is a significant relationship between FDI, EXR and GDP, indicates that economic growth in Nigeria is directly related to foreign direct investment and exchange rate(Adigwe P. K. (Ph.D), 2015). The main purpose of this study is to analyze the impact of foreign direct investment on Nigeria economic growth over the period of 1999- 2013. The study used The regression analysis of the ordinary least square (OLS) is the estimation technique that is being employed in this study to determine the relationship between and impact of the Direct Foreign Investment on economic growth. The findings revealed that economic growth is directly related to inflow of foreign direct investment which implies that a good performance of the economy is a positive signal for inflow of foreign direct investment(Adeleke Kunle M., 2014). This paper examined the effects of Foreign Aid on the Economic Growth of Bangladesh. The study used secondary data of 33 years data on foreign aid for 1980-2012 periods and used time series analyses to estimate the effect of Foreign Aid on the Economic Growth of Bangladesh. This study had found that, foreign aid has positive effect on the economic growth of Bangladesh and also reveals that the aid generates decreasing returns in Bangladesh because of capacity constraint of Bangladeshi institutions to utilize the foreign aid effectively(Hossain, 2014). The main objective of this study is to examine empirically the long-run relationship between per capita real foreign aid and per capita real GDP for Egypt (1960-2005) and Jordan (1965-2005). This study used counteraction by Pesaran et al. (2001)

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Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in approach to analyze the data, the Granger causality test were also used. The results of the study revealed that in the case of Jordan a long-run relationship exists between the variables, while no evidence of long-run relationship to exist in the case of Egypt(Al-Foul, 2013). This research investigated the empirical link between domestic private investment and economic growth in Nigeria. The study included the CobDouglas model framework. The model is estimated using Error Correction Modeling (ECM) approach and annual data covering 1970 to 2012. The result of tests reveals equilibrium relationship between real GDP and its determinants in the long and short-run(Kalu, 2015).

The main objective of this study is to determine dynamic interaction between domestic investment, foreign direct investment, and economic growth inPakistan for the period 1976–2010. This study used Phillips and Perron (PP) test to assess unit root in the concerned data series. Johansen cointegration approach also applied to examine the long run relationship and Toda-Yamamoto causality approach is also exercised to evaluate causal linkages.The results study reveals the existence of long run relationship between domestic investments, foreign direct investment, and economic growth(Irfan Ullah, 2014).

Conceptual frame work

H1: there is positive relationship between Foreign Direct investment (FDI) and Economic growth

Model procedure

H2: there is positive relationship between Foreign aid (FA) And Economic growths.

The purpose of this research paper is to examine the relation of Somali’s GDP with foreign direct investment, foreign aid and domestic investment.

H3: there is positive relationship between Domestic investment (DI) and economic growth.

Study covers the time period from

3. METHODOLOGY This study employed time series data on the foreign direct investment (FDI), foreign aid, domestic investment, and Economic Growth over the period of 1970 to 2014 in Somalia. Three independent variables such as: Foreign direct investment (FDI), foreign aid (FA), domestic investment (DI) is included in the model based on availability of data. The study analysis how these independent variables affect Economic growth in Somalia


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Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in GDP growth, foreign investment of Somalia.

aid

and

domestic

To examine the relation of Somali’s GDP with FDI, foreign aid and domestic investment the following multiple regression model was used. Assuming (1) to be linear in logs, taking logs and differencing, we obtain the following expression describing the determinants of the growth rate of real GDP: GDP = FDI + FA +DI + µ

(2)

Where GDP = Gross domestic product FDI = Foreign direct investment FA = Foreign aid DI = Domestic investment

The aforementioned Multiple Regression Model was run on E-Views to find out the Impact of FDI FA and DI on the Gross Domestic Product of Somalia. In this multiple regression model, GDP is used as dependent variable whereas FDI, FA and DI are measured as independent variables. 4.

DATA ANALYSIS AND DISCUSSION

For the effectiveness of this study, both descriptive and analytical techniques were employed. For the analysis of the time series data, certain statistical techniques were employed. This includes multiple regression analysis of a single – equation model based on method of Ordinary Least Squares (OLS).

Model Summary Table 1 shows the Model Summary R

1

Change Statistics R Square Change F Change

df1

df2

Sig. F Change

.801

3

41

.000

54.855

DurbinWatson 1.102

a. Predictors: (Constant), Foreign Aid, Domestic Investmen and FDI b. Dependent Variable: Gross dometic product As shown above, the coefficient of determination R-squared R2 is 0.801. This result implies that on the average about 80.1% of variations in economic growth in Somalia within the period under review is systematically explained by changes in these explanatory variables. Thus, about 19.9% variations in economic growth in Somalia remain unexplained by these explanatory variables. The unexplained variations are attributed to other external factors not included in the model.

Table 2 Regression Analyze Model

The Durbin – Watson (DW) value of 1.102 suggests that there is no presence of autocorrelation. The null hypothesis of this study is stated that the model is not significant. The decision rule follows that if the computed F-value is greater than the tabulated F – value, we reject the null hypothesis, otherwise accept. Since our computed F-statistics (54.855 is greater than the F-tabulated value (2.96) at 5% levels, therefore, we reject the null hypothesis. Thus, we conclude that the model is statistically significant and reliable.

Standardized Coefficients Beta

(Constant) DOMESTIC INVESTMENT .542 FOREGIN DIRECT INVESTMENT .222 FOREIGN AID .359 Table summarized the result obtained from regression analysis and it revealed that,


T

Sig.

9.843

.000

6.387 .000 2.403 .021 3.363 .002 domestic investment, foreign direct investment, and foreign aid have positive and

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Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in significant relationship product (GDP).

on

gross

domestic

If one percent change in FDI occurs, it will bring about 22.2% change in GDP while 1 percent change in FA will bring 35.9% change in GDP and 1 percent change in DI will bring 54.2 % change in GDP by holding other variables constant. Estimates (FDI, DI and FA) are highly significant. However, the t – statistics value when compared with the tabulated t – value at 5%, shows that the coefficients of foreign direct investment, foreign aid, and domestic investment was significant in explaining upward variations in the economy. The result reveals that foreign direct investment has positive and significant relationship on gross domestic product (GDP). This indicates that the increase of foreign direct investment brings the increase of economic growth of Somalia, on other hand slowdown increases of FDI pulled down the growth of output (GDP). Also the result shows that there is a positive relationship between domestic investment and economic growth of Somalia as well there is a positive relationship between foreign aid and economic growth of Somalia. There is a positive relationship with FDI, FA and DI on Economic growth of Somalia. The R-square of this model means 19.9% variation in unexplained by FDI and remaining variation (80.1%) FDI and GDP.

is 0.801 that the model is CPI whereas is explained by

Conclusion This study explores the influence of foreign direct investment (FDI) on economic growth in Somalia for the period 1970-2014. The results of foreign direct investment (FDI), foreign aid, and domestic investment effect on growth show that they have significant and positive effect on economic growth in Somalia.

Recommendations In the light of the above findings, the followings recommendations are proposed:1. Government should provide an environment that will attract the inflow of FDI. 2. There is need for government to formulate investment policies that will be favorable to local


investors in order to compete with the inflow of investment from foreign countries. REFERENCES (n.d.). Louzi B. & Abadi A. (2011) impact of foreign direct investment on economic growth in jordan Al-Balqa Applied University. A., L. B. (2011). impact of foreign direct investment on economic growth in jordan. Al-Balqa Applied University. Adeleke Kunle M., O. S. (2014). Impact of Foreign Direct Investment on Nigeria Economic Growth . International Journal of Academic Research in Business and Social Sciences, 1-8. Adigwe P. K. (Ph.D), E. C. (2015). Effect Of Foreign Direct Investment On Nigerian Economic Growth. European Journal of Research and Reflection in Management Sciences, 1-6. Akinpelu, Y. A. (2013). Effects of Remittance Inflows on Economic Growth of Nigeria. Developing Country Studies. Al-Foul, B. M. (2013). Foreign Aid And Economic Growth In Egypt And Jordan: An Empirical Analysis. The Global Journal of Finance and Economics, 1-8. Behname, M. (2012). Foreign direct investment and Economic growth: Evidence from southern Asia. Atlantic Review of economics, 1-12. Emmanuel Tamen Tchapchet (South Africa), C. G.I. (2014). Employee participation and productivity in a South African. Problems and Perspectives in Management,. Frenkel, M. F. (2004). A panel analysis of bilateral FDI flows to emerging economies. Economic Systems, 28 (3, )281 –300. Hossain, B. (2014). The Effect of Foreign Aid on the Economic Growth of Bangladesh. Journal of Economics and Development Studies, 1-11. Houdou Ndambendia (corresponding author), M. N. (2010). Foreign Aid, Foreign Direct Inversment and Economic Growth in SUb - Saaran Africa: DEvidence from frompooled Mean Group Estimator.

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Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in International Journal of Economics and Finance, 1-7. Houdou Ndambendia (corresponding author), M. N. (2010). Foreign Aid, Foreign Direct Investment and Economic Growth in SubSaharan Africa: Evidence from Pooled Mean Group Estimator. International Journao of Economics and Finance, 1-7. Houdou Ndambendia (corresponding author), M. N. (2010). Foreign Aid, Foreign Direct Investment and Economic Growth in SubSaharan Africa: Evidence from Pooled Mean Group Estimator (PMG). International Journal of Economics and Finance, 1-7. Houdou Ndambendia (corresponding author), M. N. (2010). Foreign Aid, Foreign Direct Investment and Economic Growth in SubSaharan Africa: Evidence from Pooled Mean Group Estimator (PMG). International Journal of Economics and Finance, 1-7. Iheke,

O. (2012). nternational Journal Development and Sustainability.

of

Irfan Ullah, M. S. (2014). Domestic Investment, Foreign Direct Investment,. Hindawi Publishing Corporation Economics Research International, 1-6.

Kalu, C. U. (2015). Domestic Private Investment and Economic Growth in Nigeria: Issues and Further Consideration. International Journal of Academic Research in Business and Social Sciences, 1-10. Leonid Melnvk Oleksandr Kubatko, S. P. (2014). The impact of foreign direct investment on economic growth: Case of post communism transition economies. Problems and Prespective mananegment , 1,3,5,7. Mamo, S. (2008). Determinats of Foreign Direct Investement in Ethiopia. Master thesis, Maastricht University. Njoupouognigni, M. (2010). Foreign Aid, Foreign Direct Investment and Economic Growth in Sub-Saharan Africa: Evidence from Pooled Mean Group Estimator. International Journal of Economics and Finance, 1-7. UNCTAD. (2014). Investement and innovation policy review: Somalia. United Nations. New york and Geneva: http://unctad.org/en/docs/poiteipcm4.en.pd f.

Appendix 1 : Macro Economic Data on FDI, FA, GDP, DI Indicator

FDI

FA

GDP

DI

1970

4,500,000.00

27,620,000.00

1971

1,700,000.00

30,570,000.00

1705715145.11

387484729.61

1972

4,500,000.00

29,730,000.00

1959541803.61

445135311.14

1973

600,000.00

50,960,000.00

1721469903.23

390647910.60

1974

700,000.00

80,950,000.00

1734423815.45

393865552.88

1975

11,790,000.00

165,400,000.00

1989300791.16

455410728.57

1976

2,200,000.00

101,150,000.00

1952539688.89

440756981.01

1977

7,780,000.00

234,950,000.00

2218970153.88

504006466.16

1978

300,000.00

263,040,000.00

2347657521.82

529976405.87


1,670,004,360.05

379851076.36

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Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in 1979 1980

-

1981

10,000.00

274,090,000.00

2230581044.22

508324493.40

30,000.00

479,960,000.00

2270574110.95

540723587.87

110,000.00

382,380,000.00

2412807517.62

506113128.18

1982

-

760,000.00

473,880,000.00

2479570137.07

580555957.11

1983

-

8,230,000.00

341,030,000.00

2192523125.89

479734720.42

1984

-

14,940,000.00

347,590,000.00

2264123616.32

540216395.86

1985

-

710,000.00

350,710,000.00

2479892661.80

717730136.72

1986

3,060,000.00

506,500,000.00

2426676081.08

793573759.03

1987

64,340,000.00

587,070,000.00

2671472352.42

894711899.77

1988

-

43,390,000.00

431,720,000.00

2656691899.25

609286871.27

1989

-

41,160,000.00

419,150,000.00

2652018464.24

741209913.52

5,590,000.00

514,810,000.00

2609590851.32

721122604.98

1990 1991

-

150,000.00

186,420,000.00

2583491941.25

662308413.47

1992

-

60,000.00

653,660,000.00

2273471707.62

582769137.36

1993

2,000,000.00

892,120,000.00

2273471707.62

586906774.67

1994

1,000,000.00

535,120,000.00

1796052254.01

430788697.72

1995

1,000,000.00

187,930,000.00

1796052254.01

430381083.47

1996

1,300,000.00

88,180,000.00

1866094585.00

431981672.89

1997

1,100,000.00

81,180,000.00

1815667708.86

414791588.95

1998

40,000.00

81,320,000.00

1860991865.28

427178147.82

810,000.00

115,700,000.00

1920543604.97

459592884.82

2000

270,000.00

102,230,000.00

1978159913.11

454750014.84

2001

40,000.00

149,300,000.00

2037504710.51

488965431.97

2002

140,000.00

152,720,000.00

2108817375.38

470996831.65

1999

-


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Imperial Journal of Interdisciplinary Research (IJIR) Vol-2, Issue-12, 2016 ISSN: 2454-1362, http://www.onlinejournal.in 2003

-

850,000.00

176,180,000.00

2182625983.51

469697852.57

2004

-

4,790,000.00

201,280,000.00

2248104763.02

471576643.98

2005

24,000,000.00

240,220,000.00

2315547905.91

470912220.31

2006

96,000,000.00

396,170,000.00

2371121055.65

499111167.00

2007

141,000,000.00

393,740,000.00

2432770203.10

505480673.91

2008

87,000,000.00

765,870,000.00

2496022228.38

517076739.03

2009

108,000,000.00

661,640,000.00

2560918806.32

534047734.64

2010

112,000,000.00

505,680,000.00

2627502695.28

546239995.19

2011

102,000,000.00

1,098,980,000.00

2695817765.36

559992269.70

2012

107,330,000.00

990,130,000.00

2765909027.26

575453898.35

2013

107,110,000.00

1,054,250,000.00

2837822661.97

589956737.48

2014

105,500,000.00

1,109,380,000.00

2911606051.18

605293098.01

Source: world Bank


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