ABSTRACT
Studies have established mixed results on the relationship
between financial market development and foreign direct investment. However,
governance has been identified in literature to influence both financial market
development and foreign direct investment, yet no study has considered the
interacting of financial market development, governance and foreign direct
investment. Thus, this study is of the view that governance could probably
influence the relationship between financial market development and foreign
direct investment in Sub- Saharan Africa. The study purported to examine the
interacting role of governance in the relationship between financial market
development and foreign direct investment in Sub-Saharan Africa from 1997 to
2016. The study was backed by Eclectic theory and new institutional economic
theory. The study adopted Generalized Method of Moment (GMM) technique. The
study first found positive relationship between financial market development
and foreign direct investment in Sub- Saharan Africa. Secondly, it found
positive relationship between financial market development and foreign direct
investment in Sub- Saharan Africa. Finally, it found that governance plays an
interaction role in the relationship between financial market development and
foreign direct investment in Sub-Saharan Africa. Hence, this study suggests
that Sub-Saharan economies should enhance both their financial market and
governance (specifically, control of corruption, regulatory quality, political
stability and voice and accountability) in order to maximize inflows of foreign
direct investment.
CHAPTER ONE
INTRODUCTION
There have been mixed results in
literature on previous studies that established relationships between financial
market development and foreign direct investment. Thus, this study was
conducted with the intention of rectifying the mixed results in literature by
introducing governance as an interacting variable because of its dual impact on
foreign direct investment and financial market development.
Background to the Study
Foreign direct investment (FDI) and
financial market as well as governance are vital elements in achieving
sustained growth in any economy, including Sub-Saharan African economies (Adam,
2009; Coy & Cormican, 2014; Asiedu, 2006).
Foreign direct investment (FDI) is
essentially an international investment where the investor gains significant
influence in the management of a firm outside the investor’s home country (Solomom,
2011). FDI has become an important force in the internationalisation of
investment activities in the global economies. For instance, the inflows of FDI
globally were $ 1,114 billion in 2009 (United Nation Conference on Trade and
Development (UNCTAD), 2011).
Foreign direct investment (FDI)
remains one of the most important forms of cross-border capital flow in
Sub-Saharan Africa (World Bank, 2014). It has been established that, foreign
direct investment plays a significant role in the economy of Sub-Saharan Africa
(Adam, 2009; Jugurnath, Chuckun & Fauzel, 2016). That is, FDI is seen as a
source of economic development, modernisation, income growth and
employment (Organisation for economic co-operation and development, 2002).
Despite the importance of FDI in promoting economic growth and development
agenda, Sub-Saharan African countries continually attract low level of FDI over
the years as compared with other regions (Cantah,Wiafe & Adams,2013). This
is confirmed by data from world bank, which depicts continuous fall of FDI in
Sub- Saharan Africa:
This has necessitated the continuous interest of Sub-Saharan
Africa researchers in FDI.
Among the determinants of foreign direct investment is
financial market development (Soumaré &Tchana, 2015). Due to massive
evidence in literature about the significant role of financial market
development in an economy’s growth (Arestis, Demetriades & Luintel, 2001;
Demirgüç-Kunt &Levine, 2004) the study intend addressing the limitations in
literature examining relationship between financial market development and
foreign direct investment.
Huang (2006) described financial market development (FMD) as
the process of improving efficient allocation of financial resources by
strengthening healthy competition, leading to increase in the overall relevance
of the financial system. The Global Competitiveness Report (2016 – 2017),
expatiated on FMD by stating that a well-organized financial system allocates
the resources saved by citizens of a nation as well as those of foreigners to
entrepreneurs with the highest expected rates of return. Investing in business
is very crucial to productivity. Therefore, economies require financial markets
with certain activities that can benefit the private-sector such as credit,
sound banking and well regulated financial sector. In order to perform these
activities, the banking sector needs to be reliable and transparent, and it has
been made so clear recently that financial markets need befitting regulation to
protect investors in the economy.
Financial market development (FMD) is one of the variables
that has been use as an independent variable to foreign direct investment in
literature, however, works on financial market development and foreign direct
investment have given mixed results. For instance Otchere, Soumaré and
Yourougou (2016) and Desbordes and Wei (2017) found positive association
between financial market development and foreign direct investment while Wang
& Liu (2017) found negative relationship between them. In addition, Soumaré
and Tchana (2011) found the relationship between financial market development
and FDI to be ambiguous and inconclusive because some of the indicators of
financial market development used in their studies had significant relationship
with FDI while others did not.
Hence, this study sought to clear this inconclusiveness by
considering the absorptive capacity of financial market development on
governance in its relationship with foreign direct investment. That is, the
link between financial market and foreign direct investment is dependent on the
nature of governance which have been classified over the years to be weak in
the economies of Sub-Saharan Africa (America Security project, 2014; Kandiero
and Chitiga, 2006). This is because governance structure serve as an important
factor that boosts foreign direct investment (Agyemang, Fantini & Ansong,
2016; Mengistu & Adhikary, 2011 ), as well as financial market development
(Law & Azman-Saini, 2012).
Therefore, even if the level of financial market development
in these economies is in line with our expectation, its contribution to the
level of foreign direct investment cannot be fully realized if governance
structures such as control of corruption, government effectiveness, political
stability and absence of violence, rule of law, regulatory quality and voice
and accountability are weak in economies of Sub – Saharan Africa.
Statement of the Problem
Studies have established the relationship between FMD and
FDI, nevertheless, the results have been mixed and inconclusive. While Otchere,
Soumaré and Yourougou (2016) and Desbordes and Wei (2017) established that
financial market development has a positive relation with FDI, Wang and Liu
(2017) found negative correlation between FDI and financial market development
in eastern and central region of China. Moreso, according to Soumaré and Tchana
(2011), the relationship between financial market development and FDI is
ambiguous and inconclusive because some of the indicators of financial market development used in their
studies had significant relation with FDI while others do not.
Though inconclusive, some studies have established that FMD
have significant relationship with FDI (Otchere, Soumaré & Yourougou, 2016;
Desbordes & Wei, 2017). Meaning, FMD has a substantial influence on the
inflow of FDI. This has necessitated Sub – Saharan Africa countries making
significant effort to improve their financial market, (Gabriele, Boratav, &
Parikh, 2000) in an attempt to increase inflows of FDI. In spite of this, data
from World Bank on FDI indicates otherwise, the inflow of FDI is continuously
falling. For instance foreign direct investment inflow as a percentage of gross
domestic product was 2.70%, then it fell in 2012 to 2.40%, it fell further in
2013 to 2.36%, it increased just a little in 2014 and 2015 to 2.38% and 2.69%
respectively and reduced by 2016 to 2.56% (World Development Indicator, 2018).
This trend could be attributed to the weak governance
structure in the economies of Sub- Saharan Africa, which (that is, governance
structure) has been argued to play an important role in improving both foreign
direct investment (Mengistu & Adhikary, 2011; Agyemang, Fantini &
Ansong, 2016) and financial market development (Law & Azman-Saini, 2012).
Also, these mixed or inconclusive results in literature could
be explained by weak governance structure in the countries of Sub- Saharan
Africa. Therefore, this study intends to address the limitations of previous
studies which examined both the relationship between FMD and FDI (Mengistu
& Adhikary, 2011; Agyemang, Fantini & Ansong, 2016) and FMD and governance in isolation (Law & Azman-Saini, 2012) by
interacting FMD, governance and FDI in this study.
It is against this background, this study sought to examine
the role of governance structure in the FMD-FDI nexus in Sub- Saharan Africa
countries.
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