The Impact of Foreign Direct Investment in the Economic Growth of Kenya

The Impact of Foreign Direct Investment in the Economic Growth of Kenya

 

Globalization performs a major role in the development and improvement of different countries around the world. Many aspects can be considered as a basis of a nation’s participation in globalization, such as trade relations, output, inflow and outflow of income, and many others. Technology also plays an essential role in the development of a nation, and its utilization to perform trade relations is beneficial for a much bigger range of market and exchange of goods and services.

Due to the crucial role of globalization, the issue of foreign direct investment (FDI) becomes an essential basis for the development of a country. It has been reported that foreign direct investment is defined as a long-term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based, and creates a relationship consisting of a parent enterprise and a foreign affiliate forming a Transnational Corporation ( 2006). In addition, in order to qualify as a foreign direct investor the investment must afford the parent enterprise control over its foreign affiliate ( 2006), and becomes important to attract other foreign investors to a particular nation. With this basis, nations are aiming to attract different foreign investors to increase foreign direct investments and in turn, increase their output and world trade relations.

With the important role of foreign direct investments, this paper discusses its impact to the economic growth of the nations in Africa, particularly to Kenya. Compared to other continents around the world, Africa produces the least amount of output and attracts the least number of foreign investors. This paper seeks to answer questions, such as why Kenya fails to attract foreign investors to their country, and how the country can evaluate their performance in attracting foreign investors.

 

Literature Review

            It has been reported that foreign direct investment has increased tenfold over the last 20 years, and brings private overseas funds into a country for investments in manufacturing or services (2006). It can bring impressive growth, as in China’s coastal provinces, but also instability and economic distress, as during the 1997-98 Asian financial crisis (2006). In addition, government of many poor countries see foreign capital as a means of economic growth, and they have taken steps to attract it, including minimizing business regulation and weakening codes for labor, health, and the environment (2006). Such governments may also try to improve the investment climate by using violence to silence opposition parties and movements, while rich countries, for their part, have sought legal protection for investors, and have used the World Bank and the IMF to impose new arrangements in this field (2006). Bilateral and multilateral agreements, such as the North American Free Trade Area, protect investments at the expense of environmental and health regulations ( 2006). The proposed Multilateral Investment Agreement (MIA), under negotiation at the World Trade Organization, would replicate this imbalance at the global level ( 2006).

            For this reason, attracting foreign direct investment has become a key part of national development strategies for many countries (2006), including the countries in Africa such as Kenya. Some impact of foreign direct investment includes the country’s economic growth, trade, employment and skill levels, technology diffusion and knowledge transfer, and linkages and spillover to domestic firms (2006). On the other hand, while many highlight FDI’s positive effects, others blame FDI for “crowding out” domestic investment and lowering certain regulatory standards, and can sometimes barely be perceived, while other times they can be absolutely transformative (2006). 

One study suggests that research on 39 developing countries implies that it is the composition, or structure of foreign investment that has the greatest impact on the economies of developing countries, rather than the total amount of foreign capital received (2003). In addition, it is the high foreign investment concentration, and not foreign investment itself, that hinders economic growth in countries (2003). High concentration levels allow foreign corporations to gain control over many economic, political, and social dynamics in a host country, thereby reducing the ability of the state and local elites to implement a national economic policy in their country’s own long-term interests (2003). Moreover, states become weak and often corrupt, and dependence on export duties makes elites less willing to use demand-side stimuli to spur domestic economic growth (2003).

However, despite the mentioned drawbacks of foreign direct investments, countries still strive to attract as many foreign investors to increase their yield financially and economically and support their government. As a proof of this, a high level of foreign investment in Singapore was accompanied by rapid economic growth, while other countries with relatively high amounts of foreign investment, such as Bolivia, Mexico and Malawi, grew slower than countries with less foreign capital (2003). Furthermore, Kenya, with the lowest level of foreign investment, had a stagnant economy, yet other countries with low levels of foreign investment, such as the Philippines, El Salvador, and the Dominican Republic, had much stronger economic growth (2003). For this, the government of Kenya must device ways on how to attract foreign investors, for producing great effects to their economy.

It has been reported that the great majority of Kenyans are engaged in farming, largely of the subsistence type, such as coffee, tea, sisal, pyrethrum, corn and wheat, which are grown in the highlands, while coconuts, pineapples, cashew nuts, cotton, sugarcane, sisal and corn grown in the lower lying areas (2006). Much of the country is savanna, where large numbers of cattle are pastured, and produces dairy goods, pork, poultry, and eggs (2006). The country’s leading manufactures include consumer goods such as plastic, furniture, textiles, cigarettes, and leather goods; refined petroleum, processed food, cement, and metal products ( 2006). Furthermore, industrial development has been hampered by shortages in hydroelectric power and inefficiency and corruption in the public sector; however, steps have been taken to privatize some state-owned companies ( 2006). Kenya attracts many tourists, largely lured by its coastal beaches and varied wildlife, which is protected in the expansive Tsavo National Park ( 2006). Kenya’s chief exports are tea and coffee, which is tremendously affected by the fluctuation in world prices ( 2006). Major trading partners are the United Kingdom, Uganda, Tanzania, and the United Arab Emirates ( 2006). The population growth in Kenya continually exceeds the rate of economic growth, resulting in large budget deficits and high unemployment ( 2006).

From the assessment of the economy of Kenya, it can be deduced that Kenya has the capacity and ability to make good international relations with other countries. Kenya must maximize the use of its natural resources and labor to help with the success and development of its economy. One way to attract a number of foreign investors in the nation is to show them first of the desire of the country to improve itself, and show its initiative for development. The internal development of Kenya will be useful for attracting investors, and contribute to the economic growth of the country as a whole.  

Methodology and Work Plan

            (2006) reports that foreign direct investment is regarded as a major catalyst for Africa’s new growth and development strategy. For this reason, many studies were conducted to examine and evaluate the effects of foreign direct investments to these countries. The AERC Special Workshop in FDI in Africa has studied the determinants of such investment and analyzed what countries need to do in order to integrate into the global financial markets, and were discussed at a research workshop held in Nairobi in December 2004, that identified areas of further research on the links among FDI, growth and poverty reduction (2006).

            In the Kenya case study, analyzed the various factors that constrain improved net inflows into Kenya and examined whether the country responds differently to the various determinants of foreign direct investment than other countries (2006). Among the issues analyzed are the magnitudes of net FDI inflows, their composition and sectoral destination, as well as the economic, political and other factors that might influence them (2006).

            Another study was done by the United Nations, being concerned with the situations, particularly with the economy and trade relations of different countries around the world. This study was done to evaluate the economic performance of Kenya, in terms of measuring the examining the flow of foreign direct investments. This study also includes the policy reviews in Kenya, and the steps of the United Nations on how to improve foreign direct investments to this country.

 

Possible Findings

            In general, the decline of foreign direct investment flows to Africa or the poor response by Transnational Companies to Africa’s efforts to attract FDI, is because Africa as a whole does not compare favorably as regards a number of basic determinants of FDI, including a stable political environment, the size of markets and per capita incomes, the rate of and prospects for economic growth, infrastructure, and the overhang of indebtedness (2006). In addition, Africa is said to have lacked what was the “driving force of FDI in other regions, such as debt equity swaps linked to privatization, broad and deep privatization of juicy firms and the absence of, poorly developed, capital markets able to attract portfolio capital ( 2006). Even where countries have undertaken massive privatization offers and overhauled policies for growth, FDI response remain poor because it is said, investors do not have sufficient confidence in the African economies (2006).

            (2006) reports that the study asserts that there has been high volatility in foreign direct investment flows to Kenya and concludes that FDI has not played an important role in the Kenyan economy despite the reforms that have been undertaken and the many incentives provided to foreign investors. Among other things, the study cites the deteriorating business environment in the 1980s and 1990s, which formed a major deterrent to the flows of foreign direct investments (2006).

            Another study suggests that Kenya was a magnet for foreign direct investment in East Africa in the 1960s and 1970s, however the country has under-performed significantly in terms of FDI attraction in the past couple of decades (‘Investment Policy Review: Kenya’ 2002). The reasons include poor or inconsistent economic policies, deteriorating infrastructure and poor growth performance, and the rising corruption and insecurity discouraged FDI throughout the 1980s and 1990s (2002). A wide array of Transnational Companies are nevertheless present in the country, and FDI has played a key role in some of the dynamic sectors of the economy ( 2002). The Investment Policy Review finds the investment framework to be relatively sound on paper, but to be lacking in terms of implementation (2002). It warns the government on the possible drawbacks of the recently adopted Investment Promotion Act, which introduces minimum capital requirements for FDI entry, and proposed amendments to lift these requirements ( 2002). The IPR also recommends a more pro-active strategy of FDI attraction and proposes policy measures to enhance the impact of FDI on growth and economic development, focusing on four pillars: 1) the manufacturing of basic consumer goods and industrial inputs for the regional market, 2) the development of Kenya into a regional services hub, 3) agri-business activities, and 4) diversification of activities in export processing zones (2002).

             The development of the economy of Kenya is not attributed to the flow of foreign direct investments, but through the remittances, the government receives from the Kenyan overseas workers and migrants in other countries. It has been reported that Kenyans are contributing an equivalent of 3.8 percent of national income through remittances (2006). Furthermore, in the year 2004, Kenyans living and working abroad remitted about Ksh35 billion, which is equivalent to $464 million, and overshadows the net foreign direct investment of Ksh3.6 billion, equivalent to $50.4 million, and is accounted for 0.41 percent of the country’s gross domestic product (2006). In addition, analysis of household surveys indicates that remittances have been associated with significant declines in poverty in several low-income countries, including Uganda (11%), Bangladesh (6%), and Ghana (5%) (2006). Remittances also appear to help households maintain their consumption levels through economic shocks and adversity (2006).

            (2006) also reports that the study proposes that developing countries seek agreements with countries to which their nationals migrate, to improve the conditions under which they cross borders, seek and maintain employment, and send a part of their earnings home. The development of the economy is Kenya is also associated with increased household investments in education and health, as well as increased entrepreneurship (2006). In addition, the report estimated that remittances reduced the number of people living in absolute poverty in Kenya, and that migration relieves labor market pressures by reducing unemployment and increasing domestic wages (2006). Furthermore, international “brain drain” that’s happening to Kenya can boost the wealth of migrants as well as the countries they originate from, and if remittance policies are improved, migration can be of all-round benefit (2006).

            Certainly, foreign direct investments are not the only factor that determines the economic growth of Kenya. Although many factors affect this nation’s economic development and growth, foreign direct investments are still important on the determination and measurement of its success and improvement, in terms of financial and economic status. Overall assessment of this paper states that Kenya lacks certain aspects of social development and order and financial stability. These observations are the reasons why foreign investors are not attracted to invest money and resources to Kenya. By identifying Kenya’s incapacities to impress foreign investors, its government must act and improve their status for their economic development. It can be concluded that the economy of Kenya is still considered to be behind and slow moving due to the problems presented in the paper. If the government of Kenya desires to attract more foreign investors to their country, then they must provide solutions to the problems mentioned, and foster a considerable environment for the citizens. This entails the increase in improvement of infrastructures, increase in the quality of education and skills training, and increase in the quality of healthcare to the entire country of Kenya.