Sector Analysls Of The Absorptive Capacity Factors In The FDI/Growth Relationship

This thesis seeks to analyze salient issues associated with economic growth looking at the relationship between the foreign direct investment (FDI) and economic growth in Botswana. The main focus of the thesis is to analyze the country’s absorptive capacity factors specifically looking at key factors such as human capital and the technology gap. These two factors are important in determining the country’s readiness to assimilate the positive externalities from FDIs. The absorptive capacity issues are analyzed in the context of the growth effect of FDI inflow into the different sectors of the economy, especially the manufacturing sector. The thesis further examines the determinants of FDIs in Botswana looking at the type of FDIs the country is seeking to attract.This report contains three main empirical chapters structured such that the first empirical chapter establishes the impact of FDI on economic growth both at the aggregate level and across the different sectors of the economy. This chapter starts by proving that indeed FDI has an impact on economic growth at an aggregate level and further analyzes the growth effect of FDI at sector level. The main questions of interest are; whether or not FDI inflow into the economic sectors has a different effect on growth? Why the manufacturing sector has seemingly failed to grow at the anticipated rate? What are the salient issues that have stunted its growth? These questions are all within the general context of the country’s absorptive capability. The second empirical chapter looks at the absorptive capacity factors to try and answer questions such as; why does Botswana continue to experience only few FDI flows in spite of favorable macroeconomic conditions? Does Botswana have what it takes to attract the right FDIs? Does Botswana have what it takes to fully exploit benefits accrued from FDIs? Is Botswana focusing on the right policies? The third empirical chapter centers on the location specific determinants of FDI in Botswana. This chapter seeks to answer questions related to whether or not the decision to locate to Botswana depends on the type of FDI or on prevailing conditions within the country; whether or not Botswana is attracting the right FDI? Are they targeted at the right sectors? what are the location specific determinants of FDI in Botswana? The motivation of the thesis, its aims and structure, including a brief background on Botswana is discussed in chapter one. Chapter two provides a theoretical framework on the FDI-growth relationship and reviews a survey of empirical economic literature on the relationship between FDI and economic growth. It further provides the literature on empirical studies on the growth effect of FDI on different economic sectors, on absorptive capacity factors as well as the determinants of FDI. Chapter three gives a brief background on the performance of the economic sectors in Botswana and the policy framework and presents an empirical analysis of FDI and economic growth both at the aggregate level and the sector level. The time series co-integration technique and fixed effects estimation using panel data are applied to investigate the FDI/growth relationship at the national and sector levels respectively. The empirical results demonstrate that while FDI has a positive effect on growth at an aggregate level, the growth effect varies across the different sectors of the economy. The results show that the FDI growth effect is positive on mining, financial services, manufacturing, and other selected sectors, the relative significance of the impact varies dramatically across the different sectors; with the manufacturing sector registering an insignificant growth effect from FDI compared to mining and financial services. The results of chapter three attest to the dominance of the mining sector both at attracting FDI and the significant growth effect that FDI has on it.Chapter four empirically investigates country pre-conditions that are not only necessary to attract FDI but that enables externalities from FDIs to effectively benefit the economy. The results show that FDI has, in general, a significant positive impact on growth in Botswana. However, the degree of the effect depends on the country’s absorptive capacity. The absorptive capacity in this analysis is measured by human capital, technology gap and trade openness. Generally the findings point towards weak absorptive capacity although results show a positive relationship of human capital with economic growth while the technology gap negatively impacts growth. The results show that the country must reach a threshold level of absorptive capacity in order to gain the positive externalities offered by FDI inflows.Chapter five discusses the specific country location determinants of FDI in relation to the type of FDI and the targeted sector. This chapter used factor analysis (Principal Component Analysis) to deduce determinants of FDI in Botswana. The choice of variables of interest used in the analysis was based on findings from empirical studies, literature and the availability of data. The results of the factor loadings and scores showed that natural resources, market propensity, infrastructure and trade openness are key determinants of FDI in Botswana.Chapter six presents a summary of findings from the empirical analysis and provides a conclusion on the aim of the thesis with regard to the research questions. Furthermore, policy recommendations are made based on the findings of the thesis and within the general context of conditions prevalent in Botswana. They take into consideration the country’s long term development strategy of diversifying economic growth away from the mining sector through the development of the manufacturing sector, with a view to address issues of unemployment and poverty. Furthermore the recommendations point towards targeted policy interventions that assume a more balanced approach between building the country’s capacity to assimilate FDI externalities and providing incentives to attract FDI.The key contribution of the thesis is not only to bridge the gap in the body of knowledge by presenting a country case study on the FDI/growth effect, but it provides empirical evidence and highlights areas that impede the development of the manufacturing sector. It takes into account the influence of the host country’s absorptive capacity, the sector specific needs and different types of FDI. This thesis demonstrates that having a high economic growth rate does not always translate into increased flows of FDI; contrary to economic literature that maintains that the opposite is true; where more FDI inflows leads to economic growth and in the process attracts more FDI inflows. The findings show that Botswana has weak absorptive capacity in terms of skilled human capital and technological readiness and this has had an adverse impact in the attraction of FDI and the assimilation of externalities from FDI.