Macroeconomic determinants of foreign direct investment in Ghana

Abstract

This study examines the macroeconomic determinants of Foreign Direct Investment (FDI) in Ghana, using the Johansen Multivariate co-integration technique. Some elements of the Neoclassical and Electic approaches to the determinants of FDI are used to develop a dynamic simultaneous equation model and then the system is estimated simultaneously by using the Full Information Maximum Likelihood (FIML) method. The Granger Non-causality test is used to determine how the endogenous variables drive each other. The long-run equations for exchange rate, foreign direct investment, domestic price level, real output, and natural resources are estimated so as to know the long-run partial elasticities. The relative importance of each endogenous variable in accounting for its own behaviour and that of the other variables in the VAR system is pointed out by decomposing the forecast error variance. The impulse response functions are used to study the impact of a random shock in one of the endogenous variables on the other endogenous variables. The impact of Economic Recovery Programme and Political instabilities on the endogenous variables is also examined. It was realized that there is bi-directional causality between the rate of inflation and the growth rate of real output, the growth rate of the exchange rate and the growth rate of natural resources, the rate of inflation and the growth rate of natural resources, the growth rate of exchange rate and the rate of inflation as well as the growth rate of real output and the growth rate of natural resources. However, there is a uni-directional causality between the growth rate of the exchange rate and the growth rate of FDI, the growth rate of foreign direct investment and the growth rate of natural resources as well as the growth rate of FDI and the growth rate of real output. But the foreign direct investment and the rate of inflation do not predict each other and also the growth rate of the exchange rate and the growth rate of real output do not granger-cause each other. In the exchange rate market, the long run determinants are the rate of inflation, natural resource growth and the real output growth. Foreign direct investment constraint is determined by the rate of growth of the exchange rate and the real output growth. The rate of inflation is determined by the rate of growth of the exchange rate, the rate of growth of foreign direct investment, natural resource growth and the rate of growth of real output. The rate of growth of the exchange rate, the rate of growth of foreign direct investment and the rate of inflation are also seen as the long run determinants of the rate of growth of real output in the labour market. The natural resource growth is determined by the growth rate of the exchange rate and the rate of inflation. The exchange rate can therefore, be used as policy tool to influence foreign direct investment growth in Ghana. The government can influence the level of FDI inflow in the long-mn by using the exchange rate as a policy instrument and also improving the level of productivity as a strategy. To enhance the exploitation of natural resources, there is the need to stimulate the inflow of foreign direct investment and also to improve the income level of the people.