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Determinants of Foreign Direct Investment and Economic Growth in the West African Monetary Zone: A System Equations Approach

Eli A. Udo & Isitua K. Obiora University of Ibadan,

May 1, 2006

Abstract

Although the theory of diminishing returns to capital postulates that capital should be invested where its ratio to other production factors is low, evidence on the flow of Foreign Direct Investment (FDI) speaks to the contrary. Slightly more than 70 percent of world FDI in the past 20 years has gone to developed countries, where capital/labour ratio is much higher than in the developing countries. Although the literature on the FDI- growth nexus is burgeoning, this paper departs from earlier studies by specifically analyzing the candidate determinants of FDI in the West African Monetary Zone (WAMZ) and investigating the cause-effect relationship between FDI and growth. Using a simultaneous-equations method on a panel of WAMZ countries over the period 1980 to 2002, we find no evidence of a two-way causal relationship between FDI flows and economic growth. Rather FDI tends to be attracted by high per capita income, better infrastructure and political stability. Hence, any meaningful attempts at attracting FDI must take cognizance of these determinants.

Key Words: FDI, Economic Growth, WAMZ, simultaneous equation, Granger Causality.

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