Accepted Manuscript

Title: Foreign direct investment and economic growth: ADRL

and causality analysis for South Africa

Author: Tafirenyika Sunde

PII: S0275-5319(16)30120-9
DOI: http://dx.doi.org/doi:10.1016/j.ribaf.2017.04.035
Reference: RIBAF 651

To appear in: Research in International Business and Finance

Received date: 24-6-2016

Revised date: 23-4-2017
Accepted date: 24-4-2017

Please cite this article as: Sunde, T.,Foreign direct investment and economic growth:
ADRL and causality analysis for South Africa, Research in International Business and
Finance (2017), http://dx.doi.org/10.1016/j.ribaf.2017.04.035

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Foreign direct investment and economic growth: ADRL and causality analysis for
South Africa
Tafirenyika Sunde
Namibia University of Science and Technology (NUST)
tsunde@nust.na
Abstract
The article empirically investigated economic growth as a function of foreign direct

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investment and exports in South Africa. The article applied the autoregressive distributed lag

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model, known as the ARDL bounds testing approach to cointegration for the long run
relationship between economic growth, foreign direct investment and exports. The error

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correction model was used to examine the short run dynamics; and the VECM Granger
causality approach was used to investigate the direction of causality. The article confirmed

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cointegration between economic growth, foreign direct investment and exports. The article
indicates that both foreign direct investment and exports spur economic growth contrary to
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some studies, which found that FDI does not cause economic growth. The VECM Granger
causality analysis found unidirectional causality between economic growth and foreign
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direct investment running from foreign direct investment to economic growth, unidirectional
causality between foreign direct investment and exports running from foreign direct
investment to exports and bidirectional causality between economic growth and exports. The
d

article confirms the FDI-led growth hypothesis for South Africa. On the policy front, the
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government should stimulate foreign direct investment through incentives to investors,

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creation of a good macroeconomic environment and a careful utilisation of loose monetary

policy to grow the economy.
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Keywords: foreign direct investment; economic growth; exports; bounds testing; ARDL;
VECM; Namibia
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Biographical notes
Tafirenyika Sunde is a Senior Lecturer at the Namibia University of Science and Technology
(NUST) formerly called the Polytechnic of Namibia. He previously worked at the University
of Zimbabwe (UZ) and Midlands State University (MSU) as a Teaching Assistant and
Lecturer, respectively, before joining the then Polytechnic of Namibia in 2008. He has
published several research articles in refereed international journals. His research interests
include Macroeconomics, Econometrics and Public policy.

Page 1 of 23
1. Introduction
There have been many arguments in both theoretical and empirical literatures, which suggest
that economic prosperity is associated with significant inflows of foreign direct investment
(FDI) into a country. This resulted in many researchers conducting studies that investigate
the theories of FDI, various economic variables that influence FDI, the effects of economic
integration on the movements of FDI, and the benefits and costs of FDI (see Adams, 2009;
Frimpong, Oteng-Abayie, & others, 2006; Kandiero & Chitiga, 2006; Sharma & Dhakal,

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1994; Gui-Diby, 2016; Ayanwale, 2007; Jenkins & Thomas, 2002; Afolabi & Bakar, 2016).

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The majority of these studies confirm there is a positive causal relationship between FDI and
economic growth, in either the short run, or long run, or both. Frimpong, Oteng-Abayie, &

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others (2006) studied the causal relationship between FDI and economic performance in
Ghana. Their findings suggest that there is no causality between FDI and economic growth in

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Ghana. However, studies by Afolabi & Bakar (2016) and Keho (2015) on the Nigerian and
South African economies, respectively, established that there is bidirectional causality
between FDI and economic growth. an
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The differences in the results alluded to above may imply that the advantages of FDI do not
occur automatically, but rather depend on recipient countries' absorptive capacity, such as a
free trade policy, export-oriented FDI policy and human capital development (Zhao & Du,
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2007). Studies on the causal relationship between FDI inflows and economic growth have a
major role since they speak to economic development. If there is unidirectional causality
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from economic growth to FDI, this suggests that national income growth can be utilised as a
catalyst to attract FDI inflows. On the other hand, if unidirectional causality runs from FDI to
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economic growth, this strongly suggests that FDI stimulates the economic growth, increase
gross fixed capital formation and employment (Borensztein, De Gregorio, and Lee 1998; Lim
and Maisom 2000; Zhang 2001). If a bi-directional causality exists between these variables,
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then both FDI and economic growth would have a reinforcing causal relationship and the
policy makers can target both simultaneously to grow the economy.

Although numerous studies have been carried out on FDI and economic growth elsewhere,
very few previous studies have examined the causality between FDI and economic growth for
South Africa. In addition, there is very little literature on FDI and economic growth on
Southern Africa. The country is chosen because it is one of the countries ranked as a middle-
income country in the Southern Africa and it will be interesting to find out the role played by
FDI to its economic prosperity. The main contribution of the article to literature is that it is
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Page 2 of 23
one of the few attempts to analyse the causal links between foreign direct investment and
economic growth in a middle-income country of Southern Africa.

The remaining sections of the article are as follows. Section 2 presents brief empirical
literature while, Section 3 provide the theoretical models linking FDI and economic growth.
Section 4 discusses econometric techniques used in investigating the causal relationships. The
results are discussed in Section 5, and finally the conclusions and policy implications are

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presented in Section 6.

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2. FDI inflows into South Africa

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Data shows that commencing in 1994 South Africa was able to increase its FDI. However,
FDI inflows remained highly unpredictable during the subsequent two decades (Figure 1) as

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the economy tried to respond to the global crisis and the local exchange rate fluctuations. The
volatility in FDI is due to the sensitivity to commodity price changes since South Africa’s
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FDI is mainly associated with the export sector (e.g., gold or coal) even though the
importance of the manufacturing sector and financial sector has significantly increased
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recently. It should be noted that FDI inflows decreased by 20 percent between 2001 (US$ 7.3
billion) and 2002 (US$ 1.5 billion). This was mainly due to a depreciation of the South
African Rand against the US$, by 37% as this caused increased investment risk and led to
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capital flight.
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Figure 1: South Africa FDI net inflow (US$)

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Source: World Bank Indicators, 2014

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After 2006, FDI inflows into South Africa started rising again. These dynamics correspond to
the global commodities price boom, which took place between 2006 and 2009 (Wöcke and
Sing, 2013). According to Bezuidenhout (2009), FDI that is directed at a certain commodity,
as is the case of South Africa, might have limited or even a negative effect on economic
growth, due to weak linkages and spill over effects. In this case, the absorptive capacity will
only have a limited role to play.

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Table 1 indicates that FDI inflows as a percentage of GDP using five-year averages since

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1994 has never surpassed 2%. It should be noted that between 2009 and 2013, FDI inflows to
GDP fluctuated between 1.0 percent and 2.6 percent (Wöcke and Sing, 2013). Further, the

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annual growth between 2009 and 2010 was a negative 0.6 percent and it slightly improved in
2013 to 0.9 percent growth. Moreover, South Africa reported one of the lowest contributions

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of FDI to GDP (1.02% in 2011), when compared to other developing countries, for instance,
Chile (7.0%) and Malaysia (4.3%) (Wöcke and Sing, 2013).
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Table 1: Five-year average annual growth (in percentage), 1994-2013
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Period FDI/GDP
1994-1998 0.9
1999-2003 2.0
2004-2008 1.8
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2009-2013 1.6
Source: Word Bank Development Indicators (2014)
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2.1 FDI and the policy environment

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In the process of attempting to attract larger inflows of FDI in the early 1990s, South Africa
started promoting enhanced integration with the SADC region by entering into various
bilateral free trade agreements (BITs) (Strauss, 2015). This was implemented within the
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Growth, Employment and Redistribution (GEAR) strategy, which aimed at fighting poverty
and inequality. GEAR also aimed to foster economic growth, through increased economic
liberalization, strengthening of the exchange rate, deregulation, the control of capital and
decrease in the domestic deficit (Barbour, 2005). Taylor and Nel (2002) caution that one
needs to be careful, when analysing these new policy directions, as globalization tends to
benefit a narrow elite of MNCs, than the society as a whole. For South Africa, increasing FDI
provided the opportunity to contribute significantly to the GEAR goal of 400 000 job-
creation annually (Strauss, 2015). FDI represented an important source of funding given the
small domestic savings rate for South Africa, and this helped to improve the foreign currency
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Page 4 of 23
reserves (Kransdorff, 2010). This strategy puts emphasis on promoting employment in the
manufacturing sector by developing investment incentives since South Africa is highly labour
abundant. To increase FDI in the manufacturing sector programs such as the Motor Industry
Development Program (MIDP) and Strategic Investment Program (SIP) were instituted.

In spite of these efforts, investment remained low, since these incentives barely outweighed
the cost of doing business in South Africa caused by a high crime rate, low rate of skilled

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workers in this sector and a highly fluctuating exchange rate (Barbour, 2005). Even though,

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prospects for the rise of foreign investment were high and supported by the government, by
partly privatizing Telkom and the acquisition of De Beers by Anglo American in the 1990s,

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the implemented policies did not result in a significant and stable increase of FDI or any
expected positive spill-over effects in knowledge and technology. This supports the opposing

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view that there exist other factors influencing FDI. These unsatisfactory outcomes made the
government recognize that the benefits of FDI are not automatic and this led to a policy
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strategy shift and the creation of the National Development Plan (NDP) in 2001. The NDP
aimed at inclusive and more regulated programs to promote growth and reduce accelerating
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unemployment (Wood and Wentworth, 2014).

In the past, limiting trade liberalization was necessary to protect the domestic economy from
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foreign competition. This has now changed because the economy is now fully liberalized and
this has enabled the South Africa´s government to develop new FDI policies, which
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concentrate on achieving greater benefits out of new foreign direct investments (Wood and
Wentworth, 2014). As part of this strategy, the government pushed for increased local content
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of new FDI investments by putting into practice the black economic empowerment (BEE) act
of 2003. This strategy obliges companies to provide a certain percentage of ownership (26%),
management shares as well as supply orders to black individuals and firms, the so called
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“previously disadvantaged South Africans” (Wöcke and Sing, 2013, p. 11). According to
Wöcke and Sing (2013) this, however, presents burdens to potential investors, as these
requirements make direct investment in South Africa more costly. In addition, these FDI
legislations are extended by various incentives for foreign investors such tax incentives,
which in the case of South Africa are relatively weak, compared to other developing
countries. Additionally, Kransdorff (2010) argued that South Africa´s nominal corporate tax
rate is the highest among the developing countries in the sample with 37.5%, while the
second highest Tunisia that has a rate of 35% and Bulgaria reports the lowest tax rate of 15%.

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An examination of the historical and current investment dynamics shows clearly that the
individual factors of absorptive capacity are relatively well developed in South Africa
compared to the other countries in the SADC region. However, due to the lack of linkages
between FDI receiving sectors and other industries in the economy, the potential benefits of
FDI appear to be limited. It appears as if the FDI results have no impact on the economy
because South Africa has high inequality amongst the different population groups. Therefore,
the FDI investments may sometimes affect the GDP per capita growth positively without

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having a direct influence on the welfare of the poor in South Africa.

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2.2 FDI and sectoral investments in South Africa

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A second argument on why FDI has not been found to impact economic growth in South
Africa is related to the critical examination of the economic sectors receiving the FDI

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inflows. According to the Strauss (2015), the manufacturing sector is one of the most
important sectors of the economy of South Africa, even though its contribution share of GDP
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has decreased from 1993 onwards due to the structural change of the economy.
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Table 2 shows that FDI was mainly allocated to sectors whose economic importance was
declining such as mining and manufacturing. It should be noted that FDI investment in the
finance sector drastically decreased after 2008 in spite of the fact that its overall economic
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contribution increased during the same period (Strauss, 2015).

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Table 2: Contribution of FDI stocks to total FDI in South Africa by industry, 2001-2010
Sector/Industry 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Total 100 100 100 100 100 100 100 100 100 100
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Primary 33.6 31.8 34.1 31.6 33.9 41.1 44.3 31.0 33.6 38.4

Agriculture, hunting, 0.2 0.3 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1
forestry fishing
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Mining, quarrying and 33.5 31.5 34.0 31.4 33.8 40.9 44.2 30.9 33.4 38.3
petroleum
Manufacturing 24.1 26.3 24.8 31.4 27.3 27.0 26.2 32.4 27.9 25.9
Services 42.2 41.9 41.0 37.0 37.0 31.9 29.5 36.6 38.5 35.7
Electricity, gas & water 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Construction 0.5 0.7 0.6 0.6 0.4 0.3 0.3 0.3 0.2 0.2
Trade 4.1 5.2 4.4 4.1 3.0 2.6 3.7 4.9 3.6 3.4
Transport & communication 2.4 4.0 7.3 4.0 1.9 2.3 1.7 2.5 7.5 8.3
Finance 35.2 31.9 28.6 28.2 31.6 26.6 23.7 28.8 27.1 23.8
Community, social services 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1
& personal services
Source: Statistics South Africa (2015)

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Page 6 of 23
UNTACTAD (2012) reported that in 2010 the majority of FDI was allocated to the primary
sector (38.4%), 35% of total FDI in services, and 26% in the manufacturing sector (see
Figure 2). Figure 2 further shows that the share of FDI in manufacturing and services is
currently declining, while investments in mining (primary sector) are steadily recovering
since 2008.

Figure 2: Share of FDI stock by sector

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According to Strauss (2015), even though mining has not been one of the main contributors
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GDP anymore, over the past ten years, she found that it still hosted the main share of FDI
until 2010 (see Figure 2). This information is supported by Austen (1987), who argues that
mining historically has offered the highest profits and encouragements to allocate fixed
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investments, compared to other types of products and export industry.

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3. Brief literature review

There are a few studies analysing foreign direct investment and economic growth in Africa
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among which the following can be cited as recent: Akinlo (2004), Fedderke & Romm (2006),
Agbloyor et al. (2014), Adams & Opoku (2015) and Seyoum, Wu, & Lin (2015). Articles by
Akinlo (2004) and Fedderke & Romm (2006) analyse the relationship between FDI and
economic growth using cointegration analysis for Nigeria and South Africa during the
periods 1970 to 2001 and 1956 to 2001, respectively. Adams (2009), Agbloyor et al. (2014),
Adams & Opoku (2015) and Seyoum, Wu & Lin (2015) focus on subsets of African
countries, using other types of estimation methods such as instrumental variable methods, and
vector auto-regressive models. Using ordinary least squares estimators and fixed effect
models on 42 Sub-Saharan African countries for the period 1990 to 2003, Adams (2009)
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established that FDI does not influence economic growth. In another study, Adams & Opoku
(2015), applied the generalized method of moments (GMM) estimators to a dataset of 22
Sub-Saharan African countries for the period 1980 to 2011 and concluded that FDI does not
have an independent impact on economic growth. Moreover, Agbloyor et al. (2014) found
that FDI has a negative impact on economic growth in the case of 14 African countries based
on GMM estimators. Borensztein, De Gregorio, & Lee (1998) tested the effect of foreign
direct investment (FDI) on economic growth in a cross-country regression framework,

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utilising data on FDI flows from industrial countries to 69 developing countries over the last

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two decades. Their results suggest that FDI is a significant vehicle for the transfer of
technology, contributing relatively more to growth than domestic investment. However, the

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higher productivity of FDI holds only when the host country has a minimum threshold stock
of human capital. A study by Frimpong, Oteng-Abayie, & others (2006) analysed the causal

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relationship between FDI and economic performance in Ghana and found that there is no
causality between FDI and economic growth in Ghana. However, studies by Afolabi & Bakar
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(2016) and Keho (2015) on the Nigerian and South African economies, respectively,
established that there is bidirectional causality between FDI and economic growth. The
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results summarised above show that there is no consensus about the effect of FDI on
economic growth in African economies. Criticisms of some of the studies may be based the
choice of countries at different levels of development, periods studied, methods used, etc.1
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4 Theoretical Models
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4.1 FDI-led Growth hypothesis

The hypothesis of FDI-led economic growth is based on the endogenous growth model,
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which states that FDI associated with other factors such as human capital, exports,
technology transfer and capital have had important effects in spurring economic growth
(Borensztein, De Gregorio, and Lee 1998; Lim and Maisom 2000). These growth-spurring
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factors might be introduced and nurtured, to stimulate economic growth through FDI. In
addition, some recent studies recommend the inflow of FDI might be able to stimulate a
country's economic performance through technology transfer and spill over efficiency (See
Shakar & Aslam, 2015 and Borensztein, De Gregorio, & Lee, 1998). Shakar & Aslam (2015)
further argue that spill over efficiency is thought to occur when domestic firms are capable of
absorbing the tangible and intangible assets of multinational corporations (MNCs) embodied
in FDI. Further, as FDI generates backward and forward linkages, when MNCs contribute
technical assistance to domestic firms, it is anticipated that the level of technology and

1
The article does not criticise any particular article on its own for brevity’s sake.
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Page 8 of 23
productivity (for both labour and capital) of domestic producers will rise (Borensztein et al.,
1998).

4.2 Growth-led FDI hypothesis

In contrast to the hypothesis of FDI-led economic growth, the GDP-led FDI hypothesis is
mainly based on the theory of MNCs. According to Dunning (1977, 1993 and 1995)’s
Eclectic theory, MNCs with certain ownership advantages invest in another country with

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locational advantages, and both advantages can be captured effectively by "internalising"

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production, through FDI. The hypothesis of growth-led FDI, therefore, centres on locational
factors, such as market size (proxied by GDP or GNP), as the most important factor in

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attracting foreign direct investment. A high rate of economic growth, ceteris paribus, will
increase foreign direct investment, and this results from the expected higher level of

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profitability. High rates of economic growth will cause levels of aggregate demand for
investments (both domestic and foreign) to rise (Zhang 2001). In addition, better economic
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performance suggests better infrastructural facilities and greater opportunities for making
profits. As a result, the greater the market size the greater the inflows of FDI into the
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recipient countries.

4.3 Feedback causality hypothesis

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Seetanah & Khadaroo (2007) contend that there is a possibility that feedback causality exists
between FDI and economic growth. This is because large market size leads to rapid economic
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growth, which in turn increases the flow of FDI and subsequently increases profitability
levels. Moreover, this fosters economic performance resulting from the high level of
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aggregate demand. Therefore, it is not surprising to conclude that there exists positive
feedback between FDI and economic growth, due to the interdependence between these two
variables. The next section covers the methodological issues and procedures employed in the
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article.

5 Estimation and testing procedures

In this section, we discuss all the relevant techniques employed to carry out this article. These
include the unit root tests and Bounds Test for cointegration and causality within the ARDL
modelling approach. This model was developed by Pesaran et al. (2001); and can be applied
irrespective of the order of integration of the variables (irrespective of whether regressors are
purely I(0), purely I(1) or mutually cointegrated. This is specifically linked with the ECM
models that are called VECMs.
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5.1 Testing for unit roots
The first step is to determine the order of integration of each variable since the ARDL uses
each variable at the level at which it is stationary. To test the stationarity of the series, the
article uses the Augmented Dickey Fuller (ADF) unit root testing procedure (Dickey and
Fuller, 1979) and the Phillips Peron (PP) test (Phillips & Perron, 1988). In both the ADF and
the PP tests, the size of the coefficient 𝛿2 is the one that we want to determine in the
following equation:

t
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𝑛

∆𝑍𝑡 = 𝛿0 + 𝛿1 𝑡 + 𝛿2 𝑍𝑡−𝑖 + ∑ 𝛽𝑖 Δ𝑍𝑡−𝑖 + 𝜀𝑡 [1]

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𝑖=1

The ADF regression tests for the existence of unit root of 𝑍𝑡 , in all model variables at time t.

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The variable Δ𝑍𝑡−1 expresses the first differences with 𝑛 lags and final 𝜀𝑡 is the variable that
adjusts the errors of autocorrelation. The coefficients, 𝛿0 , 𝛿1 , 𝛿2 , and 𝛽𝑖 are the ones
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estimated. The null and the alternative hypothesis for the existence of unit root in variable 𝑍𝑡
is:
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𝐻0 : 𝛿2 = 0 𝐻1 : 𝛿2  0
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The other method used to test for unit roots is the Phillips Peron method, which corrects for
serial correlation and heteroscedasticity in the error terms by directly modifying the test
statistics without including lags (Enders, 2004). Thus, the equations and hypothesis to be
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tested are similar to the ones for the ADF above except that the lags of the variables are
excluded from the models.
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∆𝑍𝑡 = 𝛿0 + 𝛿1 𝑡 + 𝛿2 𝑍𝑡−𝑖 + 𝜀𝑡 [2]

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5.2 Testing for Granger causality in the Bounds test approach

Since the application of the model has proved capable of generating more reliable estimates
in the context of endogenous variables (Gujarati, 2009), the current article also applies the
Bounds Test to examine the causality between FDI and economic growth in South Africa. If
applied correctly the ARDL Bounds Test is a useful tool for estimating and interpreting the
dynamic relationships of economic variables (Dixit, 2014; Ravinthirakumaran, 2014; Jalil,
Feridun, & Ma, 2010). It is against this backdrop that the article chooses the lag length using
Schwartz information criterion; tests unit roots of all variables by using the ADF and the PP

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Page 10 of 23
tests; and conducts cointegration tests by applying the LR test technique propounded by
Johansen (1995).

The model for the relationship between economic development and FDI utilised in this article
is derived from the model: 𝐺𝐷𝑃𝑡 = 𝑓(𝐶𝐹𝑡 , 𝐸𝑀𝑃𝑡 , 𝐹𝐷𝐼𝑡 , 𝐻𝐶𝑡 , 𝑀𝑡 , 𝑇𝑅𝐷𝑡 , where
𝐺𝐷𝑃𝑡 , 𝐶𝐹𝑡 , 𝐸𝑀𝑃𝑡 , 𝐹𝐷𝐼𝑡 , 𝐻𝐶𝑡 , 𝑀𝑡 , 𝑇𝑅𝐷𝑡 represent output, capital formation, labour
employment, the amount of FDI, human capital, new technique and international trade

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(UNCTAD, 1992). Since the degrees of freedom and inadequate sample sizes matter a lot in

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VARs and VECMs, the article only uses output, FDI and exports. The following are the error
correction models estimated under the ARDL Bounds testing approach:

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𝑝

𝐿𝑁𝐺𝐷𝑃𝑡 = 𝛼11 + 𝛿12 𝐿𝑁𝐺𝐷𝑃𝑡−1 +𝛿13 𝐿𝑁𝐹𝐷𝐼𝑡−1 + 𝛿14 𝐿𝑁𝐸𝑋𝑃𝑡−1 + ∑ 𝜙1𝑖 𝐿𝑁𝐺𝐷𝑃𝑡−𝑖

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𝑖=1
𝑝 𝑝

+ ∑ 𝛽1𝑖 𝐿𝑁𝐹𝐷𝐼𝑡−𝑖 + ∑ 𝜓1𝑖 𝐿𝑁𝐸𝑋𝑃𝑡−𝑖 + 𝜐1𝑡 [3𝑎]

𝑖=1 𝑖=1
an 𝑝

𝐿𝑁𝐹𝐷𝐼𝑡 = 𝛼21 + 𝛿22 𝐿𝑁𝐺𝐷𝑃𝑡−1 +𝛿23 𝐿𝑁𝐹𝐷𝐼𝑡−1 + 𝛿24 𝐿𝑁𝐸𝑋𝑃𝑡−1 + ∑ 𝜙2𝑖 𝐿𝑁𝐺𝐷𝑃𝑡−𝑖
𝑖=1
𝑝 𝑝
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+ ∑ 𝛽2𝑖 𝐿𝑁𝐹𝐷𝐼𝑡−𝑖 + ∑ 𝜓2𝑖 𝐿𝑁𝐸𝑋𝑃𝑡−𝑖 + 𝜐2𝑡 [3𝑏]
𝑖=1 𝑖=1

𝑝
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𝐿𝑁𝐸𝑋𝑃𝑡 = 𝛼31 + 𝛿32 𝐿𝑁𝐺𝐷𝑃𝑡−1 +𝛿33 𝐿𝑁𝐹𝐷𝐼𝑡−1 + 𝛿34 𝐿𝑁𝐸𝑋𝑃𝑡−1 + ∑ 𝜙3𝑖 𝐿𝑁𝐺𝐷𝑃𝑡−𝑖
𝑖=1
𝑝 𝑝

+ ∑ 𝛽3𝑖 𝐿𝑁𝐹𝐷𝐼𝑡−𝑖 + ∑ 𝜓3𝑖 𝐿𝑁𝐸𝑋𝑃𝑡−𝑖 + 𝜐3𝑡 [3𝑐]

pt

𝑖=1 𝑖=1

Where 𝛼11 , 𝛼21 and 𝛼31 are the constants for three equations. We can test for cointegration
ce

among 𝐿𝑁𝐹𝐷𝐼𝑡 , 𝐿𝑁𝐸𝑋𝑃𝑡 and 𝐿𝑁𝐺𝐷𝑃𝑡 using the Bounds test approach. For equations [3a],
[3b] and [3c] the F-test (normal Wald test) is used for investigating one or more long run
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relationships. In the case of one or more long run relationships, the F-test indicates which
variable should be normalised (Koop, 2005).

In equation [3a] when 𝐿𝑁𝐺𝐷𝑃𝑡 is the dependent variable the null hypothesis of no
cointegration is 𝐻0 : 𝛿12 = 𝛿13 = 𝛿14 = 0 and the alternative hypothesis of cointegration is
𝐻1 : 𝛿12 ≠ 𝛿13 ≠ 𝛿14 ≠ 0 . In equation [3b] the null hypothesis of no cointegration is
𝐻0 : 𝛿22 = 𝛿23 = 𝛿24 = 0 and the alternative hypothesis of cointegration is 𝐻1 : 𝛿22 ≠ 𝛿23 ≠
𝛿24 ≠ 0. Lastly, in equation [3c] the null hypothesis of no cointegration is 𝐻0 : 𝛿32 = 𝛿33 =
𝛿34 = 0 and the alternative hypothesis of cointegration is 𝐻1 : 𝛿32 ≠ 𝛿33 ≠ 𝛿34 ≠ 0. The
10
Page 11 of 23
distribution of F-statistic developed by Pesaran et al. (2001) is non-standard. The reason
being that the F-statistic is based on the assumption that variables are integrated at I(0) or I(1)
as alluded to earlier. If the calculated F-statistic is less than the lower critical bound (LCB)
then the hypothesis of no cointegration may be accepted. Cointegration may be found if the
calculated F-statistic exceeds the upper critical bound (UCB). In addition, the long run
relation is inconclusive if the calculated F-statistic lies between the lower and the upper
critical values.

t
ip
Once cointegration is established then there must be causality at least from one direction.
Granger pointed out that the existence of cointegration between variables means that there is

cr
information about the long run and short run Granger causality. In this case, the vector
autoregression (VAR) model is used to test the direction of causality between economic

us
growth, foreign direct investment and exports for South Africa. For empirical purposes, the
following error correction representation can be developed from the VECM Granger
approach:
𝐿𝑁𝐺𝐷𝑃𝑡 𝛼11 𝑝 𝜙1𝑖
an
𝛽1𝑖 𝜓1𝑖 𝜃 𝜂1𝑡
(1 − 𝐿) [ 𝐿𝑁𝐹𝐷𝐼𝑡 ] = [𝛼21 ] + ∑(1 − 𝐿) [𝜙2𝑖 𝛽2𝑖 𝜓2𝑖 ] + [𝜛] 𝐸𝐶𝑀𝑡−1 + [𝜂2𝑡 ] [4]
M
𝐿𝑁𝐸𝑋𝑃𝑡 𝛼31 𝑖=1 𝜙3𝑖 𝛽3𝑖 𝜓3𝑖 𝜉 𝜂3𝑡

where (1 − 𝐿) is the difference operator, 𝐸𝐶𝑀𝑡−1 is the lagged error correction term which is
ed

derived from the long run cointegrating relationship while 𝜂1𝑡 , 𝜂2𝑡 and 𝜂3𝑡 are white noise
serially independent random error terms. The existence of a significant relationship in first
differences of the variables provides evidence on the direction of short run causality while
pt

long run causality is shown by a significant t-statistic pertaining to the error correction term
(𝐸𝐶𝑀𝑡−1).
ce

5.3 Data sources

Ac

Data for economic growth rate (GDP), Foreign Direct Investment as a percentage of gross
domestic product (FDI) and exports as a percentage of gross domestic product (EXP) for
South Africa was principally obtained from the Bank of Namibia Annual Reports and the
Namibia Statistical Agency for the period 1990 to 2014.

6. Discussion of empirical results

6.1 Unit roots and cointegration tests
Table 3 provides information on the descriptive statistics of the data. Based on the statistics
the Jarque-Bera test confirms that the series of LNGDP, LNFDI and LNEXP are normally

11
Page 12 of 23
distributed. The correlation coefficients indicate that all the three variables are positively
correlated, albeit weakly. In this data, the highest correlation is observed between LNGDP
and LNFDI.

Table 3: Summary statistics the correlation matrix

Statistic LNGDP1 LNFDI1 LNEXP1
Mean 0.289746 0.452082 0.336993
Median 0.623655 0.369389 0.364817
Std. Dev. 1.068653 0.560548 0.578373

t
Skewness -0.529755 0.449283 -0.680666

ip
Kurtosis 1.903839 2.757416 3.511569
Jarque-Bera 4.357740 1.624255 3.965494
Probability 0.113169 0.443913 0.137691

cr
LNGDP 1
LNFDI 0.32807 1
LNEXP 0.11114 0.24466 1

us
Source: Author’s own computation

The article applied the ARDL bounds testing approach to cointegration to test the long run
an
relationship between economic growth rate, foreign direct investment as a percentage of GDP
and export as a percentage of GDP in the case of South Africa. This is a pre-test to check the
M
stationarity properties of the variables to ensure that no series is at I(2) and above that order
(Quattara, 2004). The ARDL bounds testing approach becomes invalid if any series is
integrated of order two. However, the ARDL bounds testing approach to cointegration is
ed

flexible to apply when the variables are I(1) and I(0) or mutually integrated.
pt

The next step is to analyse the stationarity properties of the data. Visual analysis of the
logarithms of economic growth rate, foreign direct investment as a percentage of gross
ce

domestic product and exports as a percentage of gross domestic product plotted in Figure 3
suggest that economic growth rate and foreign direct investment as a percentage of gross
Ac

domestic product are stationary in levels. Moreover, the export as a percentage of gross
domestic product series is non-stationary in levels (see Figure 3). This suggests that some of
the variables are integrated of order zero while the other variable has an order of integration
greater than zero.

12
Page 13 of 23
Figure 3: Trend diagrams of the variables
2,0

1,5

1,0

0,5

0,0

-0,5

t
ip
-1,0

-1,5

cr
-2,0
1970 1975 1980 1985 1990 1995 2000 2005 2010

us
LNGDP LNFDI LNEXP

Source: BoN and Author’s own computations

an
The formal unit root test results are presented in Table 4. These results confirm the visual
findings alluded to above. The results confirm that economic growth and foreign direct
M
investment are integrated of order zero I[0], while exports is integrated of order one [I(1)].
This implies that there is a possibility of cointegrating relationships in the VAR models. The
stationarity results are also important for Granger causality testing because the variables have
ed

to be used at the levels at which they are stationary.

pt

Table 4: Unit root testing using the ADF and the PP tests
Augmented Dickey Fuller Phillips Perron
Variable Model Test (ADF) Test (PP) Decision
ce

Levels First Levels First

Difference Difference
LNFDI Constant -3.142*** -3.145**
Trend -3.655** -3.640** I(0)
Ac

None -2.382** -2.382**

LNGDP Constant -4.557*** -4.532***
Trend -4.631*** -4.555*** I(0)
None -4.445*** -4.463***
LNEXP Constant -0.139 -4.341*** -0.103 -4.316***
Trend -1.956 -3.800** -1.961 -4.219** I(1)
None 2.5433 -3.618*** 2.6604 -3.619***
( ) indicates the t-stats, and (***), (**), (*) indicate 1%, 5% and 10% level of significance, respectively.
Source: Author’s own computation

The presence of cointegrating vectors for the model is further confirmed by analysing the plot
of the cointegrating relationship normalised with respect to economic growth as given in
Figure 4. Since this corresponds to the error-correction term (that is, the residuals of the

13
Page 14 of 23
cointegrating equation), the evidence of stationarity bolster the results of cointegrating
relations.

Figure 4: The cointegrating relationship

2,0

1,5

1,0

0,5

t
ip
0,0

-0,5

cr
-1,0

-1,5

us
-2,0
1970 1975 1980 1985 1990 1995 2000 2005 2010

Source: Author’s own computation

an
The analysis of the ARDL bounds testing approach to cointegration reported in Table 5
indicate that the calculated F-statistic, that is, 9.24784 is higher than the UCB at 1, 5, and 10
M
percent levels of significance. This indicates that a cointegrating relationship is found
between LNGDP, LNFDI and LNEXP in the case of South Africa over the period 1970 to
ed

2014.

Table 5: The results of the cointegration test

Panel 1: Bounds testing to cointegration
pt

Estimated Equation LNGDP𝑡 = f(LNFDIt , LNEXPt )

Optimal lag structure (1, 0, 2)
F-statistics 9.24784
ce

Significance level Critical values

Lower bounds (I0) Upper bounds, (I1)
1 percent 2.63 3.35
5 percent 3.1 3.87
Ac

10 percent 4.13 5
Panel 2: Diagnostic tests Statistics
R2 0.562651
Adjusted R2 0.503550
F-statistic (probability) 9.520118
Source: Author’s own computation

The cointegrating relationship is given by equation [5]: Cointeq = LNGDP1 − (0.4929 ∗

LNFDI1 + 0.4637 ∗ LNEXP1 − 0.4672) [5]. The results reported in Table 5 show the
long run and short run impacts of economic growth, foreign direct investment and exports in
South Africa. The long run analysis results show that both LNFDI and LNEXP are
determinants of LNGDP at the 5 percent level of significance. All things equal a 1 percent

14
Page 15 of 23
increase in LNGDP increases foreign direct investment and exports by 49 percent and 46
percent, respectively.

Table 5: Long run and short run analysis

Dependent Variable = LNGDP Dependent Variable =  LNGDP
(Long run) (Short run)
Variable Coefficient Std. error t-stat Variable Coefficient Std. error t-stat
Constant -0.467203 0.211151 -2.212** LNFDI 0.415868 0.217441 1.913*
LNFDI 0.492904 0.240395 2.050** LNEXP 0.229741 0.730749 4.283***

t
LNEXP 0.463733 0.229560 2.020*** ECT(-1) -0.846409 0.199541 -4.443***

ip
Diagnostic tests Statistics Diagnostic tests Statistics
J-B normality test 0.847359 (0.6556) J-B normality test 0.6742 (0.7138)
LM test 1.048067 (0.5921) LM test 0.1962 (3.2574)

cr
ARCH test 0.169121 (0.6809) ARCH test 0.7955 (0.3724)
Ramsey reset 0.33300 (0.96280) Ramsey reset 0.2083 (1.6381)
CUSUM Stable** CUSUM Stable**

us
CUSUMsq Stable** CUSUMsq Stable**
Note: (*), (**) and (***) show significance at 10%, 5% and 1%, respectively.
Source: Author’s own computation

an
The short run results are also are also in line with the a-priori assumptions since they show
that both foreign direct investment and exports significantly and positively influence
M
economic growth. In addition, as expected, the sign of the estimate of the lagged error term,
i.e., 𝐸𝐶𝑇𝑡−1 is negative and statistically significant at 1 percent level of significance. This
confirms the long run relationship between the variables established earlier. The coefficient
ed

of 𝐸𝐶𝑇𝑡−1 is -0.846 implying that LNGDP adjusts towards its long run equilibrium at the rate
of 85 percent each year. The diagnostic tests for both the short- and the long run models show
pt

that the error terms are normally distributed and they are serially uncorrelated. There is also
no evidence of autoregressive heteroscedasticity and misspecification in both models. The
ce

low standard errors in both models show that the models are efficient and that their results
can be relied upon.
Ac

The existence of cointegration between economic growth, foreign direct investment and
exports leads to the investigation of the causality relationships between the variables by
applying the VECM Granger causality framework. This gives a clear picture to policy makers
about what needs to be done depending on the results obtained among economic growth,
exports and foreign direct investment. The results relating to VECM Granger causality are
reported in Table 6. The existence of cointegration among the variables permits the division
of the causality results into long- and short run. It should be noted that the significance of the
coefficient of 𝐸𝐶𝑇𝑡−1 indicates long run Granger causality using t-statistic. In addition, the
short run Granger causality is indicated by the joint significance of the LR test.
15
Page 16 of 23
In the short run, the VECM analysis shows that there is unidirectional causality between
economic growth and foreign direct investment running from foreign direct investment to
economic growth. The results also indicate that economic growth and foreign direct
investment Granger cause exports. It is clear that economic growth and exports do not
Granger cause foreign direct investment.

t
The long run results show a slightly different picture. Whereas we found that in the short run,

ip
only foreign direct investment, Granger causes economic growth, in the long run, exports and
foreign direct investment Granger cause economic growth. Just as in the short run case, there

cr
is unidirectional causality between foreign direct investment and exports running from
foreign direct investment to exports and bidirectional causality between economic growth and

us
exports. The results of the long run t-statistic of the ECTt−1 confirm these findings. The
Granger causality tests cannot provide us information about the relative strength of causality
an
beyond the chosen time span (Wolde-Rufael, 2009; Shahbaz & Mafizur Rahman, 2014).
Wolde-Rufael (2009 further argues that the tests do not tell us anything about the magnitude
M
of the feedback from one variable to the other. The variance decomposition can assist in this
regard.
Table 6: The VECM Granger causality results
ed

Type of Granger Causality

Short-run Long run
F-statistics (p-values) t-statistic
pt

Dependent LNGDPt LNFDIt LNEXPt ECTt−1

Variable
LNGDPt - 5.305** [0.0213] 0.80597 [0.369] -5675*** [-3.1556]
ce

LNFDIt 0.45223 [0.501] - 0.35356 [0.5521 0.05918 [0.6482]

LNEXPt 4.723** [0.030] 5.483** [0.014] - -0.713** [2.3229]
Joint (short run and long run)
Ac

F-statistics (p-values)

Dependent LNGDPt , ECTt−1 LNFDIt , ECTt−1 LNEXPt , ECTt−1

Variable
LNGDPt - 11.9721*** [0.0025] 17.296*** [0.0002]
LNFDIt 1.40210 [0.4961] - 0.80777 [0.6677]
LNEXPt 7.3551** [0.0253] 10.4308*** [0.0054] -
Note: (*), (**) and (***) show significance at 10%, 5% and 1%, respectively.
Source: Author’s own computation

Applying the variance decomposition method the article establishes that close to 100 percent
of the variations in economic growth are explained by shocks to economic growth in the short
run, while in the long-run about 88 percent and 8 percent of the variation is explained by
16
Page 17 of 23
economic growth and foreign direct investment, respectively (see Table 7). In addition, the
variation in foreign direct investment is explained by shocks to foreign direct investment
(85.7 and 82.3) and exports (12.4 and 15.2) in both the short- and long run respectively. The
contribution of economic growth to variations in foreign direct investment is negligible in
both the short- and long run. Lastly, variations in exports are significantly explained by both
economic growth and foreign direct investment in both the short- and long run. The variance
decomposition results bolster the Granger causality finding explained above.

t
ip
Table 7: Variance decomposition results
Time Variance decomposition of Variance Decomposition of Variance Decomposition of
LNGDP LNFDI LNEXP

cr
LNGD LNGD LNGD
P LNFDI LNEXP P LNFDI LNEXP P LNFDI LNEXP

us
1 100.00 0.0000 0.0000 3.2789 96.721 0.0000 24.584 6.4011 69.014
2 96.231 1.1808 2.5879 1.9015 85.664 12.433 26.392 16.188 57.419
4 93.683 4.4337 1.8825 2.4485 80.932 16.618 22.294 37.464 40.240
6 90.467 6.4520 3.0803 2.2798 81.638 16.081 22.162 46.449 31.377
8
10
89.084
88.149
7.4496
8.1008
3.4661
3.7493
2.3827
2.4522
an
82.092
82.345
15.525
15.203
22.786
22.567
51.220
53.935
25.993
23.496

Source: Author’s own computation

M
The findings of the current article are slightly different from Keho (2015) who found
bidirectional causality between economic growth and foreign direct investment. In addition,
ed

the results from what Adams (2009) found. Adams found that foreign direct investment does
not influence economic growth. In another study, Adams and Opoku (2015) found that
pt

foreign direct investment does not influence economic growth. The differences in the
findings with the current study could be explained in terms of the methodologies used, the
ce

frequency of the data used and the differences in the lengths of the periods studied. The
results also confirm Fedderke & Romm (2006) who found complementarity of foreign and
domestic capital in the long run, implying a positive technological spill-over from foreign to
Ac

domestic capital which in turn increased economic growth.

6. Conclusions and policy recommendations

The article empirically investigated economic growth as a function of foreign direct
investment and exports in South Africa. The article applied the autoregressive distributed lag
model, known as the ARDL bounds testing approach to cointegration for the long run
relationship between economic growth, foreign direct investment and exports. The error
correction model was used to examine the short run dynamics; and the VECM Granger
causality approach was used to investigate the direction of causality.
17
Page 18 of 23
The results confirmed cointegration between economic growth, foreign direct investment and
exports. This implies that economic growth, foreign direct investment and exports move in
the same direction if one considers the raw data, i.e., trending upwards. The results indicate
that both foreign direct investment and exports spur economic growth. The VECM Granger
causality analysis found unidirectional causality between economic growth and foreign direct
investment running from foreign direct investment to economic growth, unidirectional

t
causality between foreign direct investment and exports running from foreign direct

ip
investment to exports and bidirectional causality between economic growth and exports. The
results confirm the FDI-led growth hypothesis.

cr
Given the findings of this research, it may be suggested that the government of South Africa

us
should endeavour to accelerate the attraction of foreign direct investment though the sectors
that are favoured by the foreign investors since foreign direct investment stimulates the
an
economic growth, increase gross fixed capital formation and employment. This can be done
by offering incentives, such as, enhanced tax holidays etc., to foreign investors who bring
M
their capital into the local economy. To increase foreign direct investment indirectly in other
sectors other than the traditional sectors favoured by foreign investors, the government can
create a good macroeconomic environment, develop infrastructure, and reduce or abolish all
ed

sorts of trade barriers. The latter will increase local production and exports and generate
competition and efficiency in the economy. In the same vein, the central bank can be directed
pt

to pursue a loose monetary policy to enhance capitalisation of the economy, which enhances
exports volume, economic growth and ultimately foreign direct investment. This is important
ce

because the size of the economy is one of the major determinants of foreign direct
investment. Other important strategies to increase FDI in South Africa include the reduction
of the high crime rate; the increase in the numbers of skilled workers through education and
Ac

training and economic stabilisation, which lead to the stabilisation of the volatile exchange
rate.

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The article empirically investigated economic growth as a function of foreign direct
investment and exports in South Africa. The article applied the autoregressive distributed lag
model, known as the ARDL bounds testing approach to cointegration for the long run
relationship between economic growth, foreign direct investment and exports. The error
correction model was used to examine the short run dynamics; and the VECM Granger
causality approach was used to investigate the direction of causality. The article confirmed
cointegration between economic growth, foreign direct investment and exports. The article
indicates that both foreign direct investment and exports spur economic growth contrary to
some studies, which found that FDI does not cause economic growth. The VECM Granger

t
ip
causality analysis found unidirectional causality between economic growth and foreign direct
investment running from foreign direct investment to economic growth, unidirectional
causality between foreign direct investment and exports running from foreign direct

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investment to exports and bidirectional causality between economic growth and exports. The
article confirms the FDI-led growth hypothesis for South Africa. On the policy front, the

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government should stimulate foreign direct investment through incentives to investors,
creation of a good macroeconomic environment and a careful utilisation of loose monetary
policy to grow the economy.
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