Foreign direct investment paper

Foreign direct investment is an investment in the form of a controlling ownership in a business in one country by an entity based on another country. It is distinguished from foreign portfolio investment by a notion of direct control. FDI includes mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra company loans. FDI involves building new facility and a lasting management interest in an enterprise operating in an economy other than that of the investor. Foreign direct investment is a sum of short-term capital, long-term capital and equity as shown in the balance of payments. It also involves participation in management, transfer technology, joint venture and expertise. Stock of FDI is basically outward FDI, less inward FDI which is net cumulative FDI for any given period.

According to Grazia letto Gillies (2012) prior to Stephen Hymer’s theory regarding direct investment in 1960’s, the reason behind FDI is explained by neoclassical economists based in macroeconomics principles. The theory was based on classical theory of trade and the motive behind trade was a result of difference in production costs of goods between two countries focusing on low production cost as a motive for a firm’s foreign activity. Intrigued by motivations behind large foreign investments made by corporations from USA, Hymer developed a framework which went beyond these existing theories explaining the occurrence of this phenomenon since he considered that the mentioned theories could not explain foreign investments and its motivations. According to Hymer’s observations, FDI is not limited to investments of excess profits abroad. FDI can be financed through loans that are obtained in host countries and payments in exchange for equity i.e. machinery.

There are three types of FDI namely; vertical, horizontal and conglomerate FDI. Vertical FDI is the one which a different but related business activities from the investors main business are established in a foreign country i.e. a manufacturing company acquiring an interest in a foreign country that supplies raw materials required by the company to make the products. In horizontal FDI, an investor establishes the same type of business operating in a foreign country as it operates in home country. Conglomerate FDI on the other hand is a type of FDI that a company makes foreign investment in a business that is not related to the one that exists in its home country.

The main determinant of FDI include;

Market size which is the main determinant of horizontal FDI and is measured by GDP or GDP per capita.

Openness– this is measured by the ratio of exports plus imports to GDP given that most investment projects are directed towards the tradable sector, a country’s degree of openness to international trade should be a relevant factor in the decision. A range of surveys suggest a widespread perception that ‘open’ economies encourage more foreign investments.

The skills of labor force– are also expected to have an impact on decision about the FDI locations. Infrastructure– it covers many dimensions like roads, railways, ports, telecommunications systems and also institutional development such as accounting. Poor infrastructure is seen as both an opportunity and also an obstacle to FDI. To foreign investors, it can attract significant FDI if host governments permits more substantial foreign participation in the infrastructure sector.

Economic growth rate– rapidly growing economy provides better opportunities for making profits than those that are growing slowly or not growing at all.

Globally, the relevance of FDI as a source of economic activity has increased rapidly over the last decade. Between 2000 and 2016, the share of FDI stock in global GDP stock increased from 22% to 35%. FDI has the potential to bring several benefits to the host countries. The arrival of multinational enterprises (MNE) improves efficiency through increased competition, it also tends to make new technology available and provides easy access to new markets. It also improves qualification and training of local workforce and increases employment and wages. The extend of these positive outcomes depends partly on the host country. They seek to invest in country with good security. For instance, the resent Dusit attack and Westgate have sacred off many investments as they fear the losses. In addition, they consider the corruption level and administrative efficiency which for Kenya is a minus. Kenya suffers from lack of transparency issue within its leaders and this does not encourage more investments but scare them

For European Union countries (EU), existing evidence shows the positive impact of FDI. Advanced economies have played a major role as the destination of FDI as well as its source. Until the onset of great recession, almost 90% of total inward foreign direct investment (OFDI) came from the advanced economies. European union and other advanced economies attracted between 60% and 70% of total inward FDI flows. Since 2008, there has been dramatic change in the global FDI landscape. The OFDI and IFDI from and into the emerging market economies (EME) had started to gain its importance. In 2014, emerging market economies represented 41% of global OFDI and 51% of the IFDI. While the European union’s share shrunk to 15% OFDI and 18% IFDI.

Over the last 16 years, EME has increased in importance as a source of FDI. The share of FDI originating from EME started to increase in 2000’s. After 2008, the rate of growth of FDI from EME accelerated and in 2014 it accounted for 41% of total OFDI. The European union and other advanced economies mergers and acquisitions (M and A) plays a prominent role in total inward foreign direct investment inflow. Between 2003 and 2016 an increased share of IFDI in the European union and other advanced economies was accounted for by mergers and acquisitions. At the global level, in the period 2003-2016, EME provided a destination for 62.7% of total Greenfield investment (GI) and 19.3% of mergers and acquisitions investment in terms of outward FDI, the European union and other advanced economies accounted for 72% of Greenfield investments and 82.4% of mergers and acquisitions investment.

Emerging multinational economies have specific motivations when investing abroad. They differ from advanced MNE’s since they are characterized by lack of ownership advantage and international experience and are adopted to low institutional quality at home. For emerging multinational economies, investing is aimed first at becoming globally competitive by filling their competitiveness gap. They seek to acquire technology and managerial skills and to access the high qualified labor. Where natural resources are concerned, they are willing to operate in host countries with low institutional quality than those that are from advanced economies.

The world’s largest MNE according to United Nations Conference on Trade and Development classification plays an important role in terms of employment and asset in the host countries that they operate in. The top company in terms of employment abroad has 800000 employees. The foreign sales volumes of one of the most prominent automotive corporations USD 190 billion which is equivalent to annual gross domestic product of countries like Greece and Portugal. Foreign assets held by the largest oil company USD 290 billion are close to the annual GDP of economies such as Ireland and Colombia.

Financial investments in Kenya remains weak considering the size of the economy and its level of development. It is one of the largest recipients for the FDI in Africa with a significant increase in the FDI inflow since 2010. United Nations Conference on Trade and Development states that in Kenya, FDI flows increased by 27% to USD 1.6 billion. The rise is mainly related to investments, coming mainly from China in the hydrocarbon sectors and mining. According to figures from UNCTAD’s 2019 world’s investment report in 2018, FDI influx to Kenya raise significantly to USD 1.6 billion from USD 1.2 billion in 2017. Total stock of FDI stood at USD 14.4 billion in 2018. In the recent years, the ICT sectors has attracted most FDI due to arrival of fiber optics in 2009-2010. Other sectors targeted by FDI include banking, infrastructure, tourism and extractive industries. The United Kingdom, Belgium, China and South Africa are main investors in Kenya.

The government has been taking measure and implementing reforms to attract FDI. Through this, the country made progress in the doing business ranking published by the world bank. After gaining sixteen places in the 2017 report, twelve places in the 2018 report, it gained further nineteen places in the 2019 report, reaching a rank of 61 out of 160 countries. Kenya simplified producers for business creation, shortened the term of process, strengthened access to credit and minority investor protections, simplified property registration process, eased tax payment and revolved insolvency easier.

The development of public private partnership as part of ‘vision 2030’ strategy should have a positive influence on FDI inflows. Kenya plays a pivotal role in the East African Community acting as regional economic hub. It benefits from growing entrepreneurial middle class, a diversified agriculture and expanding services sector, strategic geographical local with sea access and recently discovered hydrocarbon resources. This factor may attract the foreign investments.

Kenya projects FDI will surge to over sh.200 billion this year riding on renewed investor interest and confidence in the country’s business climate. In the Kenya-Japan investment forum in Nairobi the managing direct said “the FDI is growing very strongly. This year we expect inflows to grow by more than 100 per cent because of an improved business environment. According to Kenya National Bureau of Statistics, Kenya imports from Japan increased to sh. 86.6 billion. In 2014, from sh.58.2 billion recorded in 2010. Kenya’s exports have increased to sh. 5 billion in 2013 from sh.2.1 billion in 2010.

This figure is from word bank 2018.

Figure 1: Graphical representation of the IFDI in Kenya since 2007 to 2018.

FDI inflows to Kenya have transformed the service industry, manufacturing and based sectors. In 2013, Kenya’s economic output was calculated to be 5.5 trillion, up from sh.4.5 trillion the previous year, propelling the country to among the top ten largest economies in Africa. A newly instituted board of Kenya Investment Authority has set an ambitious target of launching a one stop investment centers by December and raising the country’s share of FDI by 8% during its term. The agency which was unveiled by new directors said it expects foreign capital inflows to raise to32% of Kenya’s gross domestic product up from 24%. FDI is expected to create new job opportunities while bringing to the country new expertise thus contributing to GDP. Therefore, the study seeks to find out summative effect of the FDI on our economy.

1.2 Statement of The Problem

In the recent years, foreign direct investment has played a major role in the economic growth of Kenya. Though there are rewards and downsides of foreign investment in an economy, this research aims at proving that the advantages of foreign investment greatly outweigh the disadvantages (for instance the increase in output from 4/5 to 5.5 trillion in 2012 to 2013). The inflow of foreign investment has led to improved technology and capital distribution in the country. The study looks into the positive impact and the negative wile still evaluating the possible explanations for the negative impacts. According to the world bank, foreign investment levels in the country have been below the average expected for a sustainable economic growth due to the size of its economy. Various factors have scared off investors from doing business in the region. Amongst the drawbacks of foreign investment in Kenya are corruption, technology level, managerial skills and labor and insecurity. Insecurity within the region has attributed to the low investment levels since investors are not willing to risk doing business in an unfriendly territory. Incidents like the attack of the US embassy in 1998, the post-election tribal clashes in 2007, the Westgate mall attack in 2013 and the recent terrorist attack at Dusit hotel in 2018 are red lights for investors not to invest in the country. Corruption within the administrative system of the country greatly reduced the likelihood of foreign investment in the region. A recent study found out that Kenya loses 800 billion to corruption annually. This money would have been channeled into better initiatives like proper infrastructure development which would have in turn attracted other investors. Therefore, study evaluates the various impacts and their extent on our economy brought about by foreign direct investment.

1.3 Research questions

Thus, research will be guided by the attempt to answer the following questions

1. Does FDI really complement economic growth?
2. What factors determine the effects of FDI on Kenya’s economic growth?
3. What is the degree of the impact of FDI on Kenya’s economy?

1.4 Research objectives

The main objective of the study is to find out and evaluate the impact of foreign direct investment on the economic growth of Kenya.

The specific objectives on the other hand include

1. To analyze whether or not FDI compliments growth
2. To study the factors that determine the effect of FDI on Kenya’s economic growth
3. To evaluate the degree of the impact of FDI on Kenya’s economy

1.5 Significance of the Study

The main objective of the study is to find out the impact of foreign direct investment on the economic development of Kenya. It hopes to establish whether general FDI impacts positively or negatively or is neutral to the growth of the Kenyan economy.

This study will be important in elaborating the significance of FDI to Economic Growth in Kenya. FDI stimulates economic growth and spurs economic development as a whole. The study will be a vital tool for policy makers in developing countries especially Kenya, as the evidence herein in the provision of guidelines on how to improve their economic policies so as to attract more FDI in their countries such as re-evaluate foreign relations as well as taking measures that will help reap the positive benefits of FDI.

The findings of this study will serve as a good tool for academicians as well as investors to evaluate the importance of FDI on Economic Growth in Kenya. These findings will also serve as a reference tool for researchers seeking to find out the effect of FDI on economic growth. As a result, they will come up with mechanisms to enhance the positive impacts of FDI on Economic Growth through such avenues as change of policy. This study therefore seeks to provide better understanding characteristics and trends of foreign direct investment activities

Several factors however discourage FDI in an economy. In Kenya for instance, infrastructural, regulatory and security-related constraints prevent the Kenyan economy from realizing its potential. A report by UNCTAD (2005) reveals these factors which include: government overregulation and inefficiency, expensive and irregular electricity and water supplies, underdeveloped telecommunication sector, poor transport infrastructure and high costs associated with crime and the general insecurity affect FDI and hence limiting the positive effects of FDI. Kenya, being a third world country, has had the misfortune of struggling with terrorism activities. It all started in 1998 with the bombing of the US Embassy in Nairobi. This was followed by violence over the elections of 2007. Foreign investors as well as donors have been hesitant to invest or support Kenya due to the past track record whereby the financial support issued was not put into any productive use hence depicting a case of the ever-present corruption scenario (World Bank, 2004). With the heavily disputed presidential elections of 2007, violence broke out which has seen Kenya go through an era of economic crisis which has led to a drastic fall in the standards of living amongst the people (Kinaro, 2006).This study will aid in identifying these factors that determine the effects of FDI on Kenya’s economic growth that also include Market size, inflation rate and market openness in determining if there is a positive relationship between foreign direct investment and economic growth in Kenya.

This study suggests that the Kenyan government embrace policies that aim to attract more foreign direct investment while micro-managing the same to avoid negative impacts of FDI on local firms such as crowding out. Such cases are demonstrated in the third phase from 1990 towards the year 2002, the Kenyan economy performed poorly with average real GDP falling further to 4.2% over the period. The economic performance kept deteriorating such that the average real GDP fell to a low of 2.2% (Little and Green, 2009) has underperformed drastically over the last few decades (UNCTAD, 2013).

Most research conducted about FDI is based on quantitative analyses and trends covered over the years. One goal of this research will be to combine the qualitative data gathered with the characteristics of Kenya’s economy so as to come up with custom made recommendations that suite the country. This study will also be useful in determining whether, with the data and information gathered, FDI can play a significant role in short-changing the economy of Kenya by plunging it out of the recent crisis effects towards a prosperous future.

1.6 Scope of the study

The study’s aim is to establish the effects FDI has on the Economy of Kenya on various sectors that play a key role in the Kenya’s economy. The study is limited to the Kenyan economy.

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

Conclusions from extensive literature on the FDI-growth relationship differ. This literature review therefore provides an overview of the intellectual progression of the field, as well as the main arguments and relative positions of different economists over time. This will supplement our understanding of the main discussion and allow us to establish where our research fits within the larger field of study. Gaps on how the FDI-growth relationship has been researched to date are also identified. This chapter presents a theoretical literature review as well as empirical review on theories that try to explain the impact of foreign direct investment on economic growth. Theories such as internalization theory, capital market theory, institutional FDI fitness theory, neoclassical theories among others have been reviewed. Moreover there is a summary overview of the literature reviewed.

2.2 Theoretical Literature Review

Internalization Theory

Buckley (1976) carried out a study to determine the genesis of Foreign Direct Investment and named his named it internationalization theory. His main focus was on the market imperfections that were present in technology market especially knowledge on production process. The other imperfections were observed in intermediate raw material for production.

These imperfections forced firms to opt protect their production knowledge through secrecy. This is because they found it inappropriate to use intellectual property This helped them to internalize new technologies development within themselves before transferring such knowledge to other firms.

As Buckley conducted his study, he highlighted -his findings to show the causes to these market imperfections. They included discriminatory pricing in the market. Through these minority groups were exploited. The second cause was long time-lags required to co-ordinate resources for production purposes. Thirdly, unstable bargaining positions for firms and lastly unpredictable pricing for goods on sale.

However, Buckley argued that firms could only accept to transfer their knowledge only when the firms are satisfied that the benefits accrued from conduction business abroad are greater than the costs that could be incurred doing business abroad. Firms could choose to conduct the production in home country only if they realized the costs could outweigh benefits. In such scenario’s firms could opt to produce domestically but export their produce.

Capital Market Theory

Capital market theory also called currency area theory, is considered one of the earliest theories which explained FDI. Capital market imperfections were argued to be the main drive behind the rise in levels of Foreign Direct Investments (Aliber,1970). He postulated FDI to being an outcome of differences between source and host country currencies. According to him weaker currencies have a higher FDI-attraction ability and are better able to take advantage of differences in the market capitalization rate, compared to stronger country currencies.

Moreover, in his theory he argues that source country Multi-National Corporations (MNCs) based in hard currency areas can borrow at a lower interest rate than host country firms because portfolio investors overlook the foreign aspect of source country MNCs. This gives source country firms the borrowing advantage because they can access cheaper sources of capital for their overseas affiliates and subsidiaries than what local firms would access the same funds for. The Capital Market Theory is greatly supported by situations in developed nations such as USA. However, the theory is facing a number of challenges all based on specific pillars.

Institutional FDI fitness theory rests on four fundamental pillars that help to explain about Foreign Direct Investment. The factors can be structured in a pyramid form. The first pillar is Social-cultural factors. This factor lies at the base of the pyramid. This pillar was perceived to be the most complex of all the other pillars. It was further argued to be the oldest of all the fundamental pillars. (Wilhelms,1998). Education follows closely as the second pillar, which the authors affirm to being necessary in ensuring conducive environment for FDI to thrive. Educated human capital was argued to enhances R&D creativity and information processing ability. The actual level of education does not seem to matter much for FDI as the requirements are dependent on the various skills needs of projects to be undertaken. However, what is certain is that basic education may impact on the productivity and efficiency of FDI operations, making formative education such as the ability to speak, hear, understand, interpret and implement instructions key for attracting FDI.

The third pillar was that of markets. The pillar accounts for the economic and financial aspects of institutional FDI fitness. Developed and properly functioning financial markets is a key feature in the MNC’s investment decision-making process.

The final pillar is the Government. This pillar rests at the top of the pyramid structure. It explains how big the role of the country politics is in determining foreign direct investment levels. Government fitness requires the adoption of protective regulation to manage market fitness. (Calin 2014) Government fitness is considered to include economic openness, a low degree of trade and exchange rate intervention, low corruption and greater transparency.

If policies are hostile and unfavorable towards investors, MNCs will shy away from such countries as the political instability increases the risk burden on their investments.

In conclusion, although the pyramid is represented in a specific order, the four institutional pillars in fact are inter-related and interact in unison in different forms. For example, Government policies shape markets, education and sociocultural activities; market forces impact on the Government, education and socio-culture; education affects human capital and hence Government (Wilhelms & Witter, 1998).

(Muthoga, 2003) Studied the determinants of the level of FDI in a nation such as Kenya. Among his findings were the degree of economic openness, GDP growth rate, level of domestic investment, internal rate of return and availability of credit – all proponents of Government economic policies – enhance a country’s attractiveness to foreign investors.

Institutional FDI Fitness Theory

The term FDI fitness focuses on a country’s ability to attract, absorb and retain FDI. (Wilhems and Witter, 1998). It is this country ability to adapt, or to fit to the internal and external expectations of its investors, which gives countries the upper-hand in harnessing FDI inflows. The theory itself attempts to explain the uneven distribution of FDI flows between countries.

Vamulinda and Karuranga (2010) evaluated the institutional FDI fitness model in the East African Community bloc, using Kenya, Tanzania and Uganda as their sample, and data drawn from 1995 to 2007. They found that FDI inflows were predetermined by more than a single country risk factor, such as population size, size of economy, financial market development, trade openness, infrastructure and other economic, financial and political risks. Their research also further refuted the perception that FDI inflows to Africa are attracted by natural resources. This was evidenced by that Tanzania and Uganda, both resource-poor countries, were also able to attract FDI on condition that their Governments fulfill two conditions: establish macroeconomic and political stability, and introduce an efficient regulatory framework, as well as eliminate corruption.

Neo Classical Theory for Investments

Neoclassical growth theory is an economic theory that outlines how a steady economic growth rate results from a combination of three driving forces: labor, capital, and technology. The National Bureau of Economic Research names Robert Solow and Trevor Swan as having the credit of developing and introducing the model of long-run economic growth in 1956. The model first considered exogenous population increases to set the growth rate but, in 1957, Solow incorporated technology change into the model.

The theory was first developed by Veblen in 1900. More neo classical economists tried to develop the theory further. One of the economists were Cockcroft and Riddell, (1991). They argued that the future investments flows are directly related to the package of incentives, which influence the expected rate of return; the security of the investments; the scope and speed with which companies are able to disinvest. According to neoclassical theory, FDI influences income growth by increasing the amount of capital per person. It spurs long-run growth through such variables as research and development (R&D) and human capital. Through technology transfer to their affiliates and technological spillovers to unaffiliated firms in the host economy, MNCs can speed up the development of new intermediate product varieties, raise product quality, facilitate international collaboration on R&D, and introduce new forms of human capital (Ikiara, 2003).

(Kehoe, 2006) discussed explanations of multinational production based on neoclassical theories of capital movement and trade within the Hecksher-Ohlin framework. However, they criticize these theories on the basis that they were founded on the assumption of existence of perfect factor and goods markets and were therefore unable to provide satisfactory explanation of the nature and pattern of FDI. In the absence of market imperfections, these theories presumed that FDI would not take place.

Various neoclassical theorists considered production to be directly related to reproduction. Consequently, they developed theories that helped examine FDI from the perspective of free trade. They believe that FDI spurs long-run growth through such variables as Research and Development (R&D) and Human Capital. The significant items under study in this theory were economic growth and development examines FDI from the perspective of free trade, with elements such as tax regime and macroeconomic policies affection FDI. These were theories were helpful in determining the impact FDI may have on host countries.

2.3 Empirical Literature Review

Kenya appreciates the role of Foreign direct investment in the country’s economic growth. The country has involved itself in deliberate efforts to attract, harness and sustain inward flow of foreign capital. The size of the market in the home country particularly Kenya is important in influencing the uptake of FDI which in turn strive to produce importable rather than exportable products (Shamsuddin et. al., 1994). As population grows within the home country, Kenya there is need for more valuable goods and services. This transfer to a huge opportunity for multinationals to come in and try to fill the gap within the market by providing the essential goods and services.

Zhang (2001) provided an assessment and found out that FDI seems to help in a country’s transition and promote income growth and this positive effect seems to rise over time. Carkovic and Lenin (2002) note that the economic rationale for offering special incentives to attract FDI frequently derives from the belief that foreign investment produces externalities in the form of technology transfer and spillovers. FDI is an important vehicle for the transfer of technology contributing to growth in large measure than focusing on just domestic investment

Kinaro (2006) studied the determinants of FDI in Kenya. According to him, FDI not only provides African countries with the much-needed capital for domestic investment, but also creates employment opportunities, helps transfer of managerial skills and technology, all of which contribute greatly to economic development. Further to this, he says that liberal policy frameworks have become common and are gradually losing the power to attract FDI. Through analysis of FDI levels over previous years, his study found that FDI inflows into the country were constantly decreasing.

Ngugi (2008) examined the relationship between FDI volatility and economic growth in Kenya from 1970-2010. She affirms that FDI is a key aspect of developing strategy for many developing countries and Kenya in particular. The study employed the use of various models such as the autoregressive model to determine volatility and also previous studies on economic growth and its determinants. She found that the previous studies indicated conducive business environment and favorable investment package that would attract more FDI inflow into the country. However, she concludes that, in order to maximize the benefit of FDI inflow, a central body should be established to promote and market investment opportunity so as to attract genuine capital inflow

Albert Wijeweera 2010 agrees about the positive FDI-economic growth proposition but cautions that existing evidence on this nexus does not eliminate uncertainty. As noted by Kyrkilis and Moudatsu 2011, FDI impacts positively on economic growth although causality between the two variables has not been explored comprehensively.

Abala (2014), conducted a study on the impact of FDI on economic growth in Kenya and noted that Kenya has been one of the most favored destinations of FDI in Eastern Africa. Using descriptive analysis for his qualitative data for the study, he noted that FDI steadily grew in the 1970s but greatly declined in later years due to loss of appeal to international investors. Kenya had inconsistent trends in FDI inflows since the 1780-1980 period.

Chege, 2015 carried out a study on the impact that foreign direct investment has on economic growth in Kenya based on a sample of thirty observations and noticed that there is a positive relationship between foreign direct investment and economic growth in Kenya. From a sample of 30 observations, he further opined that the coefficient of variation was at 72.5% which means that the explanatory variables explain about 72% of all changes in the dependent variable (Chege,2015).A study conducted by Sakyi, Commodore and Opuku (2015) suggested that an increase in FDI inflows trigger positive GDP growth in the long run.

Impact of Foreign Direct Investment theories

However literature review can be classified under one general theory which is FDI to growth. It tries to explain how FDI affects growth, assuming that the causation runs positively from FDI to growth and the reverse direction of causality – namely, that high rates of economic growth attract investors, explaining any positive correlation between the two.

In terms of part A, although there seems to be a general agreement in the field that FDI stimulates economic growth, the conditions upholding this differs between economists. As such, the literature on FDI led growth will be organized under the main factors that different key economists believe to be important in determining FDI and growth which include income, trade policy, the development of domestic financial institutions, the state of technology and technological gaps.

Income – Leading to different conclusions on income and its relation with FDI led growth, over the years, in the field of FDI research, there has been a rivalry between neoclassical growth theory and a newly emerging modern growth theory. Supporting the former, conventional Solovian growth theory suggests that the least affluent countries benefit most from FDI. A protagonist of this view is Findlay 1978, who claims that they are the most ‘backward’ and hence possess the most potential for improvement.

More recently however, we have Blomstrom, 1994 on the other end of the spectrum, disagreeing with Findlay. Blomstrom, who works at the Stockholm School of Economics with 37 published papers on international finance and Lipsey a professor of Economics at Columbia University with 89 publications on FDI and international trade—contradicted Solovian growth theory with their publication for the National Bureau of Economic Research, titled ‘What explains developing country growth?’. However, Blomstrom concluded that for developing countries of lower wealth, FDI has no effect on growth. They also concluded that a certain threshold level of development is needed if the host countries are to absorb new technology from FDI. Clearly competent and reliable due to their extensive experience as academics in the field, these economists and their publication was a key development in the world of FDI research as their position in the FDI field was one which rivalled neoclassical growth theory and shifted focus towards modern growth theory, which points out that a certain level of development is necessary in order to benefit from FDI, a sentiment that would go on to resonate in countless works by other economists, some of whom we shall later explore.

Human capital-Following Blomstrom work in 1994’What explains developing country growth?’, their notion of a minimum threshold of requirement in the host country’s economic state (beneath which FDI does not notably stimulate growth) became more popular over time. In the same year of their publication, Benhabib and Spiegel (1994) found that FDI is indeed an important method of adopting new technologies in order to become more efficient and increase the level of economic growth so long as the host country has a minimum threshold stock of human capital. Both of these papers were internalised in the FDI field and later cited in a 1998 paper, titled ‘How does foreign direct investment affect growth?’ written for the Journal of International Economics by three credible authors: Borensztein (who, after gaining a PhD in Economics from, is a senior staff on the International Monetary Fund), De Gregorio (the Governor of the Central Bank of Chile from 2007-2011 and a Senior Fellow at the Peterson Institute for International Economics) and Lee (who, after gaining a PhD and MA in Economics from Harvard University, is a consultant to the IMF and the World Bank). However, after reflecting on Blomstrom et al. and Benhabib and Spiegel, Borensztein et al. took a new stance to the FDI-growth conundrum, concluding that FDI not only fails to stimulate growth in developing countries with low levels of human capital, but it actually has a negative effect on them. Borensztein et al. are key economists widely published in the FDI field and this paper would later be cited by many, including Alfaro et al who emphasised the importance of human capital as a prerequisite to FDI led growth in their 2006 ‘Foreign direct investment and growth’.

Trade Policy– Contrary to the work of Blomstrom et al (1994), two years later, Balasubramanyam (1996), a Professor of Development Economics (specialising in international trade and investment) and a consultant to the OECD on the Global Forum on International Investment, published a paper titled ‘Direct foreign investment and migration’, stating that the effects of FDI depend not predominantly on income levels, but on an economy’s trade policy: host countries who pursue an outwardly oriented trade policy tend to reap the benefits of FDI on growth more so than their counterparts, particularly for export-promoting countries. Zhang (2001) agreed with this in ‘Does foreign direct investment promote economic growth?’ and concluded that trade liberalisation tends to improve education and thereby human capital conditions, whilst encouraging macroeconomic stability.

Development of Domestic Financial Institutions-Another region of the FDI-growth field focuses is development of domestic financial institutions. Although most FDI, by its very nature, relies on capital from abroad, it is important to recognise that the spill-overs for the host economy might crucially depend on this factor. As such, several economists have concluded that a lack of development can limit an economy’s ability to take advantage and benefit from potential FDI spill-overs.

Neoclassical growth theory dictates that, due to the diminishing marginal utility of capital, poorer countries will experience greater magnitudes of FDI-led growth. However, almost a century ago, economists such as Goldsmith (1969) – who used to be a member of the National Bureau of Economic research, a professor at New York University and the author of 15 books on economic history, Mckinnon (1973)- who used to be an Economics professor at Stanford University and an author of eight books on economic development, and Shaw (1973)- also a former professor of Economics at Stanford and author of multiple economics books, recognised the importance of well-developed financial intermediaries in enhancing technological innovation, capital accumulation and economic growth, heavily reliant on external finance. In the FDI-growth field they are therefore credible sources, yet arguably out-dated. More recently however, their works have been supported by economists, who have concluded that FDI has a positive impact on economic growth, but only if the host country’s domestic financial markets and institutions are well developed. In 2003, Hermes and Lensink (2003) provided evidence that only countries with well-developed financial markets gain significantly from FDI in terms of their growth rates. Two years later, Durham (2004), and two years after that, Alfaro et al (2006) both published papers that arrived at a similar conclusion, emphasising the role of financial institutions in FDI led growth since the 1970s. Indeed, this aligns with the works of Goldsmith (1969), Mckinnon (1973) and Shaw (1973).

State of Technology and Technological Gaps- Another area of the field concerns itself with the state of technology in host countries and the role that this plays in FDI led growth. This area arguably comprises the most conflict and debate.

Firstly, several economists advocate for its importance: In 2009, Toulaboe, Terry and Johansen (2009) found that technological leaders benefit most, concluding “that absorptive capacity in the host country is important in allowing FDI to positively and fully impact economic growth”. Similarly, Blomstrom interpreted the findings as indicating that foreign presence forces local firms to become more productive in sectors where ‘best practice technology’ lies within their gaps. Before these works, Findlay (1978) had postulated that FDI increases the rate of technical progress in the host country (and hence stimulates growth) though a “contagion” effect from the more advanced technology used by foreign firms.

In direct contradiction to this, however, De Mello (1996) found only weak evidence for FDI effects on economic growth, and in the following year, he pointed out that if FDI is expected to impact growth through knowledge transfers and newer technologies, then the relative impact should be lower in technological leaders than in technological laggards (de Mello (1997)).

In disagreement with all of the aforementioned findings however, the Imbriani and Reganati study (1999) showed that FDI leads to higher productivity so long as the levels of technology in the host and investing countries are similar. Li and Liu (2005)’s main argument aligns with this in the sense that they also found a negative correlation between a technological gap between home and host countries, however, they concluded that there is indeed a complementary connection between FDI and growth, unlike Imbriani and Reganati.

2.4 Summary of the literature review

The main observation from this review is that there seems to exist a relationship between FDI and growth. This relationship, however, appear to vary from country to country and therefore, countries need to be cautious with the strategies they employ to attract inwards FDI. As pointed out by (Jensen 2006), FDI forms a part of everything that influences economic growth and as such, we may not simplify and single out the growth effects of FDI from the National Accounts. In principle, therefore, studies about FDI-induced growth should extend their scope to beyond direct attribution of FDI to capture the aggregate growth effects of other factors such as prevailing macro-economic conditions, governance, legal, policy regimes and other interventions sought to spur economic growth.

2.5 Critique of the existing literature review

The policy implications of these findings from the previous studies and theories are that the countries should place more weight on stimulating growth through other measures than those aimed at attracting FDI. Blindly reducing restrictions on FDI will most likely not result in long run growth. Policies directed at stimulating domestic investment in infrastructure, technology and exports may be the better alternative in terms of promoting economic growth. Only after a country has reached a certain level of development will FDI affect growth positively.

Overall however, in terms of quantity, there is far more literature and evidence supporting the idea that FDI leads to growth. However, we should point out the limitations of previous literature: gaps in the field do appear to exist in terms of dispute in certain sub-areas. For example, the divide and inconclusively of technology gaps and their relationships with FDI in developing countries is a point of contention.

The impact of FDI on Economic growth varies with the ability of hosts to take opportunity of the benefits that come along with FDI. The major limitation with the various empirical studies also does not clearly outline whether or not FDI has positive effect on economic growth of the host country. Some theorists argue that the effects are largely positive while some argue that FDI does more harm than good to the economic growth of the host country. Local regulatory framework and policies should therefore work for provision of a conducive environment for competition to take place while at the same time avoiding the spur of monopolies. The host firms should learn from the foreign direct investors in order to grow their benefits that come along with FDI.

The empirical studies also do not clearly outline whether or not FDI has positive effect on economic growth of the host country. Some theorists argue that the effects are largely positive while some argue that FDI does more harm than good to the economic growth of the host country. Local regulatory framework and policies should therefore work for provision of a conducive environment for competition to take place while at the same time avoiding the spur of monopolies. The host firms should learn from the foreign direct investors in order to grow them.

CHAPTER THREE

METHODOLOGY

3.1 Research Design

The study adopted a descriptive survey research design. A descriptive survey research is one which employs the process of disciplined inquiry through gathering analysis of empirical data (Best and Khan, 2007). It includes fact- finding inquiries of different kinds and surveys. The major purpose of descriptive research is description of state of affairs as it exists at present. This design is appropriate where the study seeks to describe characteristics of specific groups and make predictions. It is most suitable because the study seeks to describe characteristics of various groups and make predictions. This design conceptualized the relevant factors to be considered at the same time, saving on time and costs of undertaking the study. It will further explore the link between several macroeconomic factors such as real Gross Domestic Product (GDP), Inflation, Investment, Interest Rate and Foreign Exchange.

3.2 Data Collection

To assess the impact of foreign direct investment on the economy of Kenya, secondary data was used. Secondary data was preferred in this study because it saves time that would otherwise be spent collecting data and particularly in the case of quantitative data, can provide larger and higher quality databases that would be unfeasible for undergraduate researchers to collect on their own (Novak, Thomas P .1996). Data on foreign direct investment, inflation rates,