Possible Foreign Direct Investment In South Africa Economics Essay

The global foreign direct investment (FDI) was affected by the economic and financial crisis. Currently, the global FDI is facing a medium and uneven improvement in the first half of the 2010. The developing and transitional economy is leading the FDI recovery and it will remain a favorable destination for FDI. Most regions are likely to see an improvement in FDI. The role of FDI and its nature varies according to regions. Africa has experienced an increase in FDI activity and South Africa is one of the Africa’s largest economies. South Africa is ranked 20th among the top priority economy for FDI in the world. (World Investment report, 2010). This essay will explain the theories of internationalization and the current FDI condition of South Africa and moreover discuss the factors which are responsible to attract and limit the FDI within South Africa and relate the factors to the theory.

Open climate investment and FDI have contributed to the development of the economy of South Africa. Substantial economic reforms were taken by South Africa to attract more FDI. The FDI of South Africa was lower than other emerging markets until 2002. However a development in the microeconomic conditions and South Africa’s inherent advantages, like the availability of the natural resources and a huge market size foreign investor shows very little interest in investing here. The annual average inflow of FDI in South Africa was less than 1. 5% of GDP from 1994 to 2002. The government contributed a lot to attract investment. According to the South African Reserve Bank (SARB), the UK is the major source of FDI in South Africa, followed by the Germany and the US. Finance and services, mining, and manufacturing sectors are the primary recipients of such investments. The stock of FDI was totaled $73. 7 billion in 2009 compared to $68 billion in 2008. So The FDI in South Africa increased marginally in the 2009. (Data monitor, 2010)

Figure 2: Total foreign investments in South Africa, 2005-08

Source: Datamonitor, 2010

The FDI inflow of South Africa was $5695 million during 2007 and it increased to $9006 million on 2008. However, we see that FDI inflow decreased to $5696 million during 2009. Moreover, if we look at the outflow of FDI of South Africa then it was $2966 million during 2007 and it increased to $3134 million during 2008 and decreased to $1584 million during 2009. (World investment report, 2010)

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Developing economies also invest in Africa. South Africa receives the major portion of FDI from those developing economies. Chinese FDI stock in Africa reached $7. 8 billion by the end of 2008 and South Africa is responsible for the 40 percent of this amount. (World investment report, 2010)

Figure 3: Major developing economy investors in Africa, 2006-2008

(Millions of dollars)

Source: UNCTAD, FDI/TNC database.

According to World investment report, (2010) Some TNCs from developing countries are investing in South Africa. Standard bank group and Waco international limited are two of the largest developing TNCs which are investing in South Africa.

Figure 4: The ten largest cross-border M&A deals in Africa concluded by developing country TNCs, 1991-2009

Source: UNCTAD, cross-border M&A database.

The share of African host countries in the outward stock of South African FDI has improved from 4.8% in 1990 to 21.8% in 2008, reaching almost $11 billion (Figure-5). 2,250 South African projects in other African countries were concentrated in infrastructure, telecoms, mining and energy during 2009. (World investment report, 2010)

Figure 5: South Africa’s outward FDI Stock in Africa, selected years

(Millions of dollars and per cent)

Source: UNCTAD, based on South African Reserve Bank;

More than two third South Africa’s OFDI is directed to other countries of the Southern African Development Community (SADC). Seventy percent of inward FDI of the Democratic Republic of the Congo, Lesotho, and Malawi is from South Africa.

According to the World Investment Report 2010, if we look at the distribution of FDI flows among economies by range (figure 6); we see that South Africa is responsible for out flow of FDI for the range of 1 to 1. 9 billion.

Figure 6: Distribution of FDI flows among

Economies, by range, 2009

Source: World Investment Report 2010

Identification and explanation of factors responsible to attract and /or limit the FDI flow with in South Africa:

There are a lot of factors responsible in attracting and some in limiting FDI within South Africa. This paper intends to identify and assess the main factors that have made South Africa attractive for FDI.

According to the Dunning and Lundan (2008:p 95), ” The electic paradism seeks to offer a general framework for determining the extent and pattern of both foreign owned production undertaken by country’s own enterprises, and that of domestic production owned or controlled by foreign enterprises.”The OLI model is the most popular concept which explains FDI behavior. The electic paradigm recognizes three major factors of FDI that determine ownership, location, and internalisation. It is assumed that internalisation of a firm is motivated by the ownership (O) advantage at home. This advantage is tangible only through capital and resources.

However, technologies and managerial capacities are also the intangible assets for ownership advantage. Firms gain the internalisation (I) advantage by controlling production and distribution via foreign subsidiaries in order to reduce transaction costs. In addition, the host country has some location specific advantages (L) that offer opportunities to secure cheap and valued inputs and it also includes superior market or production opportunities.

Various components of the eclectic paradigm are similar to those theories used by other scholars interested in explaining the globalization of market and production. For example, O advantages of the paradigm embrace the competitive advantage of firms as identified by Michael Porter in his various studies (Porter 1980, 1985, 1986). Michael Porter incorporated six factors (factor conditions, demand conditions, related and supporting industries, firm strategy, structure and rivalry, government and chance) in the Porter’s diamond model.

Porter’s diamond of competitive advantage offers a useful framework for analyzing the interaction between some of the main L-specific assets of countries. In addition, his analysis of the other factors, influence the extent to which an enterprise coordinates its value activities across national boundaries. Human resources, physical resources, knowledge resources, capital resources and infrastructure are included in factor condition of the porter diamond model which is important for its competitiveness. The buyers from the home market create pressure to innovate new advanced products more quickly than competitors which is known as the demand condition in the porter’s diamond model. Related and supported industry produces inputs which encourage innovation, internationalization and cost effectiveness. Firm strategy, structure and rivalry represent the fourth determinant of competiveness. The existence of intense competition in the home base is also significant which create pressure to upgrade competitiveness. (Traill and Pitts, 1998).

Figure 7: Porter’s Diamond of competitive Advantage Model

In addition, Kenworthy (1997) said that the decision to implement FDI is taken for generating profit by creating or defending a market or gaining control of inputs. Moreover, Dunning (1997) classified motives for FDI as resource seeking; market seeking; efficiency seeking; or strategic asset seeking. These motives are demonstrated below in perspective of South Africa:

Resource-seeking investment is directly related to the existence of natural resources or their processing. Government generally expected to have significant bargaining power over MNCs where this type of investment applies. The investment by the Canadian firm Placer Dome in South Africa’s mining sector may be seen as falling under this motive.

Market-seeking investment normally looks for individual or regional markets. South Africa’s manufacturing base is widely varied which limits opportunities for market capture. Historically low growth, off a low base, in Southern African Development Community (SADC) countries, may also militate against the significance of this factor, unless higher growth levels can be achieved and sustained. A management consulting firm A. T. Kearney reinforced this perception. It concluded “South Africa’s first challenge is to define its identity as an investment destination distinct from the rest of Africa” (A. T. Kearney, 2000). This suggests an important potential role for South Africa, both in terms of its leadership role in SADC and in the marketing of the region.

Efficiency-seeking or cost-reducing investment is undertaken by MNCs to provide more favorable cost bases for their operations. Efficiency-seeking FDI have a tendency to be located in countries with skilled, disciplined workforces and good technological and physical infrastructure. For example, the Mercedes Benz plant was expanded recently in Port Elizabeth by the foreign parent company Daimler Chrysler and falls into this latter category.

Strategic-asset and capability-seeking investment aims at protecting or advancing the global competitive advantages of the MNC. These kinds of investments tend to be location specific. For example, the acquisition of Safmarine by the Danish company, A P Moller, can be viewed as falling into this investment category, earning them access to a Southern shipping line. This category of investment also proposes the need to expand investor horizons to the African continent, by providing reliable information.

Political Factors:

Currently, South Africa has repaired its government and infrastructure, embracing democracy and securing foreign investment. According to the World Bank’s governance indicators (2008), South Africa is ranked in the 75. 4 percentile for government effectiveness, 67. 8 percentile for voice and accountability and 71.5 percentile for regulatory quality. (Data monitor, 2010) The government of South Africa is more open to FDI. It thinks that FDI can drive growth, improve international competitiveness, and obtain access to foreign markets. South Africa has repaired its government and infrastructure, the current president created an economic development department, which will develop economic policies consistent with the broader goals. The Department of Trade and Industry’s (DTI) Trade and Investment South Africa (TISA) division is for assisting foreign investors (Business Source Complete, 2010).

Figure 8: South Africa-key political events

The US government believes that the South African economy has strong economic fundamentals that helped South Africa to deal with the global economic crisis compared to the other developed economies. The US Ministry of Foreign Affairs stressed the need to strengthen bilateral trade ties with South Africa during the second half of 2009. There are more than 600 companies already operated in South Africa. The establishment of a US-South Africa business council is being contemplated. The South African government is also considering ways to strengthen its relations with the UAE in areas of mutual interest. So, South Africa is maintaining good relation with its neighboring countries. Moreover, South Africa is actively participating in the New Participation for Africa’s Development (NEPAD) which enables South Africa to claim international support towards ensuring political and economical stability throughout the region. This economic changes lead to the increased demand condition in South Africa. This economic change also provided South Africa with economic assurance from international organization like African Union and the Commonwealth of Nations. (Data Monitor, 2010)

The post-apartheid government sought to liberalize trade and enhance international competitiveness by lowering tariffs, abolishing most import controls, undertaking some privatization, and reforming the regulatory environment. While this has resulted in several large foreign acquisitions in banking, telecommunications, tourism, and other sectors, foreign direct investment has fallen short of the Government’s expectations. However, the current government is taking initiative to encourage merger, which increases the I-advantage of Dunning electic paradism.

The Black Economic Empowerment (BEE) strategy is a government program which ensures the best practice for employment equity, skill development, enterprise development, preferential procurement, equity ownership, and small and medium-sized enterprises. In addition, the government of South Africa privatizes some state-owned enterprises from 1995 to 2004. Other opportunities for private investment in the power sector are likely to follow Department of Minerals and Energy’s (DME) announced policy to grant up to 30 percent of new energy projects to the private sector. The planned privatization of smaller parastatals, such as Safcol (forestry) and, in the case of Denel (defense), with partial buy-ins by foreign suitors of Denel subsidiaries, also affords opportunities for foreign investment. (Business Source Complete, 2010)

Currently, South Africa is experiencing the increased FDI because of the government policies and its policies towards innovation lead to more O-advantage. In addition, current political change in South Africa leads to increased demand condition for the FDI within South Africa.

On the other hand, violent crime is a serious problem in South Africa. There are more than 18000 murders happened in South Africa in the 12 months to march 2010.Car-jacking is another major problem in South Africa. This High crime rate has negative impact on the business environment.

Moreover, Corruption is another widespread problem. According to Transparency International’s 2009 corruption index, the ranking of South Africa was 55th among 180 countries. (Data Monitor, 2010)

Economic Factors:

South Africa had an inflation of 6. 2% in 2009 because of food prices. According to the South African Reserve Bank’s inflation outlook, the consumer price index (CPI) inflation is expected to average 4. 5% in the third quarter of 2010. It is estimated by the Data Monitor that inflation will stay at 5. 2% in 2010, which is well within the 6% target range of the government. Inflation is expected to decrease to 4. 4% in 2011. (Data monitor, 2010) So, the positive economic changes impact the demand conditions which increase the competitiveness of South Africa’s FDI.

Figure 9: key economic fundamental of South Africa

Trade turnover between South Africa and Russia is only $517 million during 2009. The South African Ministry of Foreign Relations and Cooperation showed its interest to cooperate with Russia in the joint production of mineral resources in the July 2010. The two countries also want to sign a number of bilateral agreements which will favor mutual economic growth during 2010. For example, the co-operation between Mechel and Batman companies in processing nickel. (Financial Times, 2010). South African companies are interested in the development of deposits of oil and gas in Russia. So, the development in the Oil and Gas sector increases the O-advantage of South Africa as well as it also positively impacts the factors condition of porter diamond which increases the competitiveness of South Africa. Thus, the development of Oil and Gas sector attracts the FDI within South Africa.

Figure 10: South Africa’s historical GDP growth, 1991-2009

South Africa invested $4. 3 billion on the transport infrastructure, telecommunication, and Stadiums during the FIFA World Cup and it made good return from FIFA World Cup during June-July 2010 (Financial Times, 2010). The tournament has a long-term positive effect on the economy through increased investment and tourism. Government of South Africa predicted that one month tournament added .4 percentage points to the GDP in 2010. (Business Source Complete, 2010) This development of infrastructure positively impacts factor conditions which increase the competitiveness of South Africa’s FDI. In addition, it also leads to more I- advantages which help South Africa to attract the FDI.

The infrastructure of South Africa for main stream business is well developed, and it is the best in the African region. The government also wants to upgrade its transport and electric infrastructure. An investment program has taken by the government which worth $80 billion for the three years period from 2010 to 2012. This investment will positively affects the long-term growth. (Data monitor, 2010)

Figure 11 : GDP and GDP growth rate in South Africa, 2002-13

On the other hand, according to the Data Monitor, the unemployment rate in South Africa is 24. 3 % in 2009. Moreover, South African official statistics represent that 25% of the working age population was unemployed in the first quarter of 2010 (Data monitor, 2010).

In addition, South Africa has been facing severe power shortages since 2007. According to the South African statistics, (published in May 2010), the total distributable volume of electricity decreased from 241, 170 gigawatt-hrs in 2007 to 229, 599 gigawatt-hrs in 2009. (Data monitor, 2010)This shortage of power and unemployment rate can limit the FDI flow in South Africa.

Moreover, Revenue accruals through privatization were minimal during 2008. No initiative has taken for major privatization in 2009. This will also limit the FDI inflow in South Africa.

Other Factors that attracts and /or limit the FDI within South Africa:

There are some other factors which are responsible to attract and/ or limit the FDI flow within South Africa:

Figure 12: GDP composition by sector, 2009

South Africa has been facing significant decline in FDI inflows in recent years. Manufacturing brought 28. 1 percent of the country’s FDI inflows between 1994 and 2004 and that figure decreased to 18. 7 percent between 2005 and 2010. In case of mining sector, the inflow has decreased to 23. 3 percent from 29. 6 percent. One of the reasons of declining the FDI inflow because the industrial development zones (IDZs) is not spreading in other parts of the country and this makes the manufacturing and mining industry of South Africa not competitive enough to attract the FDI inflow. (Larkin, 2011)

The labor market of South Africa is characterized by the oversupply of unskilled workers and a shortage of skilled ones. A weak educational system is a key reason for the lack of skilled workers in South Africa. So, the shortage of skilled labor is a factor which can limit the FDI flow in some extent. On the other hand, the unit labor cost of South Africa is better than other emerging markets, including Mexico, Hungary, Malaysia and Singapore. Moreover, labor productivity has increased very well in recent years (South Africa. info, 2011). The low labor cost lead to more L-advantage which attracts the FDI within South Africa (South Africa. info, 2011). According to theory of comparative advantage, nations should produce those products or services for which they have the greatest relative advantages (Rugman and Collinson, 2006). So, FDI which requires low cost labor will be attracted to invest in South Africa.

The South African ministry of Energy wants to co-operate the US government in the areas of advanced nuclear systems and reactor technology. So, the government signed a belateral agreement with the US Department of energy which will improve the cost, safety, and proliferation resistance of nuclear power systems. It also improves the nuclear science and engineering infrastructure and expertise in both countries. South Africa’s Pebble Bed Modular Reactor and America’s Next Generation Nuclear Plant is an example of such project. (Business Source Complete, 2010).

IBM and Shuttle worth Foundation have praised the South African government for applying the IT standards among public sector computer systems which facilitate the accountability and transparency in public organizations and further ensure the speedy implementation of government projects and proposals (Data monitor, 2010). This investment in the technological infrastructure leads to more O-advantage.

The legal environment of South Africa is considered to be more secured for foreigners. The courts are open to foreigners in the same aspects in which it opens to the South African citizens. So, this flexible legal environment attracts FDI flow within South Africa. (ProQuest, 2010)

South Africa has become more liberal in its foreign exchange control which is another factor to attract FDI towards South Africa. (ProQuest ,2010) On the other hand, the foreign investors have to contend with a high tax burden, unstable currency, an intense regulatory environment, the supremacy of large industrial corporations in some markets and the requirement of BEE which is applicable to international companies if they seek as government contracts. These restrictions are most likely to limit the entry of FDI in the near future. (Data monitor, 2010)

Conclusion:

If we look at the above mentioned analysis of factors which attract and/or limit the flow of FDIs with in South Africa, we find that all the factors are related to the internationalization theories such as OLI theory, Porter’s Diamond theory and comparative advantage theory etc. We see that South Africa attracts the four kinds of investment, Resource-seeking investment, Market-seeking investment, Efficiency-seeking or cost-reducing investment, and Strategic-asset &capability-seeking investment. Moreover, the factors which attract the FDI either have the Ownership advantage, Location advantage or Internalization advantage of Dunning’s eclectic paradigm. On the other hand, there are some other factors which limit the FDI flow in South Africa due to the absence of key elements as identified in the Dunning eclectic paradigm such as Ownership advantage, Location advantage, Internationalization advantage.

According to the Larkin (2011), South Africa is aiming to achieve a 6 percent gross domestic product growth rate by 2015. The current government has taken a lot of initiatives to increase the FDI flow in South Africa.

According to Financial times (2010), “From banking to beer and from mining to mobile phones, South African companies have begun to establish a solid presence on the rest of the continent.” In addition, South African companies are influencing government objectives to occupy a place at the table of the BRICS countries whose growth has begun to transform the shape of the world economy. It is possible for South Africa to achieve its goals if it continues to remain focused on the factors attracting FDI and reduces those which inhibit it.