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South African Journal

of Economics
South African Journal of Economics Vol. 82:3 September 2014

FOREIGN DIRECT INVESTMENT AND TRADE OPENNESS

IN SUB-SAHARAN ECONOMIES: A PANEL DATA GRANGER
CAUSALITY ANALYSIS

MEBRATU SEYOUM

, RENSHUI WU AND JIHONG LIN*

Abstract
This study uses annual balanced panel data for 25 sub-Saharan African economies over the period
1977-2009 to investigate the Granger causality relationship between trade openness and foreign
direct investment (FDI) for the region. We took advantage of recent developments in econometric
testing techniques for Granger noncausality heterogeneous panels that takes into consideration the
effects of cross section dependence across the units of the panel data set to analyse the tradeFDI
nexus in the region. The empirical result of this study reveals a bidirectional causal relationship
between trade openness and foreign direct investment in sub-Saharan economies. Concurrently,
African countries should devote more emphasis for the promotion and attraction of FDI in order
to expand their productive capacity to produce and export; in this way, by addressing supply-side
constraints, FDI will have positive multiplier effects on trade.
JEL Classification: C19, F19, F21
Keywords: Granger noncausality, foreign direct investment, trade, sub-Saharan Africa

1. INTRODUCTION

Until recently, theoretical models of international trade have been developed distinctly
from conceptual models of foreign direct investment. The traditional neoclassical models
of international trade, which are derived from a number of explicit and implicit
assumptions of perfect markets and constant reruns to scale, were inapplicable to explain
or capture the growing complexity of cross-border transactions of international
investment and multinational corporation (MNC) activities. This led to the integration
of the theory of international investment into the theory of international trade.
As a result, the relationship between trade and foreign direct investment (FDI) has
been widely documented in the literature. However, empirical evidence on their possible
causal linkages is inconclusive, and there is still a lot of debate on this issue. The state of
the current debate on the relationship between trade and FDI comes from contradictory
* Corresponding author: Professor of Economics, Department of International Economics and
Business, School of Economics, Xiamen University, Xiamen, 361005, Fujian, China. Tel:
+86 13950137121; E-mail: linjh66@163.com

Department of International Economics and Business, School of Economics, Xiamen

University.

The Wang Yanan Institute for Studies in Economics, Xiamen University.

This research has benefited from discussions with Seyoum Mesfin. We wish to thank two
anonymous reviewers and the associate editor of this journal for helpful comments. Any remaining
errors are the sole responsibility of the authors.
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empirical findings between the two ranging from unidirectional causality, bidirectional
causality and no causality at all. Some empirical studies find a positive and strong
relationship while others find insignificant and negative relationship between the two.
Thus, the question of substitutability or complementarity between the trade and FDI
becomes an empirical question.
Recent theoretical models of international trade and FDI provide elegant and
convincing theoretical arguments for both substitutive and complementary links between
FDI and international trade. Concurrently, various empirical studies have tested those
theoretical models on aggregate and disaggregate level for different countries/regions of
the world; however, there is lack of systematic empirical investigation for sub-Saharan
African economies. The question to be addressed in this paper is the causal relationship
between trade and FDI for sub-Saharan African countries. And this study employs a panel
data approach for 25 African countries from 1970 to 2009 to empirically examine the
causal links between trade and FDI in Africa. The findings of this study indicate that
there is a bidirectional Granger causality between trade and FDI in sub-Saharan
economies.
The rest of the paper is organised as follows. Section 2 reviews the theoretical
considerations concerning trade and FDI. Discussion on the empirical literature related
to the relationship between trade and FDI for African countries and other regions is
presented in section 3. The empirical methodology and dataset analysis is outlined in
section 4. The empirical results are discussed in section 5, while section 6 concludes and
provides some policy recommendations.
2. FDI AND TRADE: THEORETICAL CONSIDERATIONS

The numerous theoretical studies that have investigated the relationship between trade
and FDI usually assess their relationship from two perspectives: whether trade and FDI
are substitutes or complements, and the direction of their causality.
Mundell (1957) was one of the most influential authors who showed from the
traditional models of international trade that FDI and trade are substitute. In the context
of the (two homogenous goods, two countries and two factors of production)
HeckscherOhlinSamuelson model, he stated that international factor mobility, which
includes FDI, is a substitute for international trade. The HeckscherOhlinSamuelson
model assumed that the only difference between countries is the relative abundances of
factor proportions. This implies that the difference between countries is essentially that of
a differing set of relative prices of factor proportions. And the free and competitive
mobility in both goods and factor markets would eventually converge the prices of goods
and factor proportions in those countries. This convergence of prices therefore removes
the basis for trade. And where there are barriers to trade, FDI and trade would be
alternative methods of involvement in cross border transactions. The notion that
international mobility of goods and services and factors of production are substitutes is at
the heart of this theoretical model.
Based on the existence of trade barriers resulting from higher transaction costs and/or
higher tariffs, the proximity-concentration hypothesis or trade-off, proposed by Brainard
(1993), Markusen (1984) and Horstmann and Markusen (1992) argues that the choice
between international trade and FDI in which firms produce same product at plants in
multiple countries depends on the trade-off between proximity and concentration.
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Proximity refers to when firms are able to take advantage of scale economies at the
corporate level generated by high fixed costs of research and development (R&D) and
other headquarter activities to set up foreign production facilitates in a foreign market to
achieve proximity. Concentration means increasing returns to scale from producing in
one plant (domestic) resulting from scale economies at the plant level. The proximityconcentration hypothesis states that firms are more likely to choose horizontal FDI over
international trade the higher transport costs and trade barriers, and the lower investment
barriers and scale economies at the plant level. This implies that the relationship between
FDI and trade is substitutive.
Brainard (1993) used a two-country, two-sector general equilibrium model where
firms in differentiated product sector choose whether to trade or set up production
facilitates in foreign market to achieve proximity. This two-sector model is characterised
by increasing return to scale at the firm level associated with the ability of firms to take
advantage of scale economies at the plant level, and where transport cost increases with
distance. The model hypothesis argues that a pure multinational equilibrium with twoway horizontal FDI supplanting international trade is possible even in the absence of
relative factor proportion differences. This is likely to be the case when transport costs and
trade barriers become higher relative to fixed plant level costs, and the greater are the
increasing returns to scale at the firm level relative to the plant level. In a similar study,
Brainard (1997) argues that equilibrium with multinational activities rather than trade is
more likely the more similar are home and host countries in terms of market size, factor
endowments and technology. This assumption is also supported by the convergence
hypothesis, Markusen and Venables (1996), which suggests that firms are more motivated
to undertake horizontal FDI relative to international trade when countries are symmetric
in factor endowments, technology and market size.
On the contrary, Helpman (1984) and Helpman and Krugman (1985) based on the
HeckscherOhlinSamuelson trade theory, developed a general equilibrium model that
allow for interplay among factor proportions, product differentiation and economies of
scale by combining multinational firm-specific assets in monopolistic competition with
international trade models. Their model predicts that if there are substantial differences
in factor proportions (capital and labour), firms from a relatively capital-abundant
country will become multinationals, and export headquarter activities such as
management, marketing skill and product-specific R&D into the labour-abundant
country in exchange for both intra-industry differentiated products and intrafirm
homogenous goods. This implies that inward FDI complements trade for the recipient
country, and if the multinational is a vertically integrated firm, outward FDI will also
complement home country trade as parent firms may export intermediary inputs to their
affiliates. This type of FDI is referred to as vertical (efficiency-seeking) FDI in the
literature. In support of this theory, Gray (1998) suggests that vertical (efficiency-seeking)
cross-border transactions between affiliates increases trade, while horizontal (marketseeking) production affiliates supplant trade.
Kojimas (1975; Kojima and Ozawa, 1984) hypothesis differentiates two cases in
which FDI works as complement to international trade or substitute to it. Elaborating on
this point, Kojima (1975) noted that FDI and international trade are complements only
when FDI is undertaken under the the principle of complementing comparative
advantage patterns or the principle of direct foreign investment (DFI) originating in the
marginal (including sub-marginal) industry. In other words, FDI should originate from
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the investing countries comparatively disadvantaged (marginal) industry or activity,

which is potentially a comparatively advantaged industry or activity in the host country.
If one reverses this argument of the hypothesis, FDI and international trade are
substitutes when FDI is undertaken from the investing countrys comparative advantage
industry. Kojimas hypothesis implicitly and explicitly assumes that foreign production
acts as a catalyst for development and efficient transfer of international resources
allocation when FDI complements trade.
Ozawas (1992) stages-based evolutionary path of comparative advantage and FDI
argues that the global economy is characterised by increasing factor incompatibility,
which is an outcome of factor-driven development process that creates a shift in a
countrys factor endowments from basic factors of production (natural resources,
abundant and inexpensive labour force) to advanced factors (skilled human capital,
availability and quality of educational institutions, and modern infrastructure). Based on
this principle, he classified countries into four distinct stages of competitive economic
development: factor driven, investment driven, innovation driven and wealth driven. He
argued that this principle dictates the operational mechanisms of multinational firms in
which FDI in factor-driven economies is undertaken to take advantage of factor
incompatibility where FDI and trade exist at the same time. This hypothesis is further
elaborated in the investment development path by Dunning and Narula (1996) and
Porters (1990) stage-based competitive advantage of nations, which argued that trade
and investment complement each other in factor-driven economies at the early stage of
economic development.
The macroeconomic approach to FDI suggests that there can be bidirectional
causality between trade and FDI in two stages. First, trade causes FDI, and slowly but
surely, FDI causes trade. Two notable theories stand out from the rest in this category:
product life cycle theory and the evolutionary perspective of FDI. The evolutionary
perspective of FDI views FDI as a series of incremental decisions that follow three
successive stages step by step to serve foreign markets. During the first stage, firms start
exporting their products via trading companies to foreign markets with similar demand
conditions. During the second stage, sales affiliates are set up to achieve proximity in
foreign markets. At this stage, firms accumulate knowledge and gain more experience
about country-specific social, political and market conditions; this accumulated
experience reduces uncertainty and increases resource commitments from home
country firms. During the third stage, FDI takes place in the host country, and
eventually MNCs subsidiaries begin to export from the host country. This is consistent
with Vernons (1996) stages-based (innovationmaturingstandardisation) product life
cycle theory.
In the final analysis, it is fair to argue that the theoretical considerations regarding FDI
and trade make no a priori conceptual assumptions to ascertain a clear-cut causality
relationship between the FDI and trade. This relationship is further complicated by
country idiosyncrasies and depends on the type of FDI, nature and extent of firm specific
ownership, and the way multinationals own, organise and use their assets (Dunning and
Narula, 1996). Therefore, the issue of substitutability or complementarity between the
trade and FDI remains an empirical question.
In what follows, we discuss previous empirical studies that have analysed the
relationship between openness and FDI in Africa as well as other developing and
developed regions.
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3. EMPIRICAL EVIDENCE

3.1 Empirical Evidence from Other Regions

Different empirical studies apply various data and econometric estimation methods to
analyse the FDItrade nexus in different regions; therefore, it is not surprising to see that
empirical evidence has so far been inconclusive.
Chiappini (2011) uses three steps bivariate framework proposed by Hurlin and Venet
(2001) to examine the causal relationship between FDI and trade for 11 European
countries over the period 1996-2008. He finds evidence of homogenous causal
relationship from FDI to exports, and heterogeneity of causal relationship from exports
to FDI; unidirectional causality is observed from outward FDI to exports for all countries
in the sample; some countries exhibit bidirectional causality while others show no causal
relationship from exports to FDI. In a similar study for the region, Herrmann and
Jochem (2005), using aggregate panel data and FDI enhanced gravity model for industrylevel data from German manufacturing firms, finds complementary relation between
trade and FDI both at the macro level and industry level for eight Central and East
European countries over the period 1994-2004.
Moreover, related studies have been also conducted for Latin American countries.
Cuadros et al. (2004), using quarterly data for Mexico (1977-1997), Brazil (1975-1997)
and Argentina (1977-1997), employed a vector autoregressive model to estimate the
causal relationship among trade, inward FDI and output. Their empirical analysis
has produced mixed results. In Mexico, FDI and trade are found to complement each
other with causality running from FDI to exports. Trade and FDI exhibit substitutive
relationship in Brazil, while in Argentina they found no evidence of causal relationship.
On the contrary, by using annual panel data for eight Latin American and Caribbean
countries over the period 1996-2008, Mohamed et al. (2010) regress the stock of FDI on
economic and institutional variables to assess the determinants of FDI for the region; they
observed complementary relationship between trade and FDI.
A number of studies have suggested similar results for south-east and Asia-Pacific
regions. For example, Stone and Jeon (2000) found significant and positive relationship
between FDI and trade. They did not carry out causality test, but their estimation results
suggest that the FDItrade relationship runs in both directions with trade flows having a
much stronger impact on FDI than the other way round. Moreover, Liu et al. (2001)
acknowledge this result for China. Using bilateral trade and FDI data between China and
19 countries over the period 1984-1998, they find bidirectional causality between trade
and FDI. The causality results indicates two-stage complementary process between trade
and FDI; growth in imports from a specific country causes increase in inward FDI from
that country; this in turn, causes the increase of exports from China to the home country
where FDI originated. According to Liargovas and Skandalis (2012), this bidirectional
causality also holds for developing countries. Using panel regression econometric model
for 36 developing countries in Asia, and Latin America from 1990 to 2008, they observe
a long-run positive relationship between trade and FDI for the sample countries.
3.2 Empirical Evidence from African Case Studies
Empirical research on the relationship between trade and FDI conducted here offers an
interesting case, and more importantly has important and relevant policy implications.
Various empirical studies have been conducted to investigate the relevance of the
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theoretical models of international trade and FDI on the aggregate and disaggregate level
for developed, emerging and developing regions/countries in different parts of the world;
however, there is lack of systematic empirical investigation for sub-Saharan African
economies. Analysis of causality relationship between trade and FDI in the African case
would help further investigate the existence of the relationship between the two variables
for countries at the early stage of development, which Porter (1990) and Ozawa (1992)
referred to as factor-driven economies, exemplified in Dunning and Narula (1996) as the
first stage of the investment development path theory.
Second, it is a well-known fact that Africa has not benefited from the dramatic increase
in the global flow of trade and investment. Over the past decades, Africa has played a
marginal role in world trade and FDI flows. Africas share in world trade and FDI flows has
been in a downward spiral trend since the 1970s. Data on Africas share of world trade
indicate that its share of world exports has declined from over 3.5% in 1970 to about 3.3%
in 2010, while its share of world imports declined from over 4.5% to 2.9% during the same
period (World Trade Organization database). Africa has also received minimal FDI, and its
share in total FDI flows to developing countries has also declined over the same period.
Africas share in total FDI inflow to developing countries was 17.4% in the 1970s, and this
figure has significantly declined to its lowest level to 3.5% in 2000, rose again to about 10%
in 2010, but still lower than what had been in the 1970s (United Nations Conference on
Trade and Development (UNCTAD database; http://www.unctad.org/fdistatistics)).
A critical factor in the dismissal performance of Africa is, among other things, due to
poorly designed macroeconomic policies in general and distorted trade and investment
policies in particular (Rodrik, 1998). Lederman et al. (2010) further suggest that
economic, legal, and institutional policies and procedures that encourage openness to
trade and FDI are required to attract investment and boost international trade. Collier
and Gunning (1999) goes further to argue that lack of appropriate trade and investment
policies is the single most important detrimental factor for growth and FDI flows in
Africa among others. Therefore, empirical findings of this research have important policy
relevance to policymakers in the region to enable them design appropriate trade and FDI
strategies.
Grnfeld and Svindal (2000) use aggregated panel data for 28 African countries over
the period 1980-1992 to investigate whether the convergence hypothesis proposed by
Markusen and Venables (1996) has any empirical relevance for the region; their results
indicate substitutive relationship between trade and FDI in Africa. Bende-Nabende
(2002) obtains a similar result based on a co-integration analysis for a sample of 19
African countries, although the relationship between trade and FDI varies across the
sample countries. Furthermore, Razafimahefa and Hamori (2005) observe similar
relationship for sub-Saharan African, Latin American and Asian countries, and went
further to suggest that the empirical findings are inconsistent with the international
theories of trade and FDI.
On the other hand, recent empirical studied for the African regions have challenged
the works of earlier researchers, who tended to observe that trade and FDI are substitutes.
For example, Morriset (1999) based on panel regression analysis explores the relationship
between trade, FDI and economic growth for African countries, while Asiedu (2002)
examines the determinants of FDI in 71 developing countries (32 African countries and
39 non-African countries); according to both Morriset (1999) and Asiedu (2002) the
relationship between trade, FDI and economic growth is complementary. With regard to
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this results, Onyeiwu and Shrestha (2004), based on a panel data analysis for 29 African
countries, further acknowledge a strong and positive relation between trade and FDI in
Africa. And this relationship tends to be even stronger for mineral resources-rich
countries. On the contrary, while there is complementary relationship between trade and
FDI for Africa, mineral resource-rich countries in the region do not have this relationship
(Seim, 2009).
Furthermore, Renard (2011) observed this complementary relationship between trade
and FDI in Africa by comparing the intensity of trade between selected African countries
and China based on data from United Nations Commodity Trade Statistics (UN
Comtrade)1 and World Bank Comparative Advantage Index. She argues that
ChinaAfrica trade reveals Africas competitive advantage that attracts complementary
investments destined for export markets to China and to the rest of the world. Similar
results are obtained by Sawkut et al. (2009) based on a sample of 20 African countries
from 1990 to 2005.
Finally, Tandrayen-Ragoobur (2011), using macro data for 48 African countries from
1970 to 2000, investigates the motivation of foreign investors in choosing Africa as their
investment destination, and to this end she distinguishes the determinants of FDI in
Africa into labour and nonlabour factors. Her findings show that higher wages do not
discourage foreign investors from investing in Africa. Moreover, she argues that high
employment level deter FDI inflows to the region. Furthermore, she suggests that the
small and poor economies of Africa deter market-seeking FDI; instead, it is the export
market that is the main determinant of FDI in Africa. She also postulates a U-shape link
pattern between FDI and aid flows, that is, initially bilateral aid seems to substitute for
FDI up to a certain threshold level and after the link becomes complementary. In the final
analysis, her findings suggest the existence of complementary link among aid, exports and
FDI in Africa.
In the following section, we describe the econometric methodology employed to test the
Granger causality between trade openness and FDI. Furthermore, we provide a detailed
description of dataset and the different measures of openness applied in this paper.
4. EMPIRICAL METHODOLOGY, VARIABLES AND DATASET

4.1 Data
Several empirical studies have described various methods on what constitute and how to
measure trade openness; however, there is no consensus on the definition of the term and
as to what is the most appropriate method to measure it. Moreover, many of the existing
measures do not adequately address the ambiguity surrounding the plethora of openness
measures, and so far no single measure is free from methodological problems; therefore,
measurement issues are likely to present a challenge for any researcher (Squalli and
Wilson, 2011; Bergheim, 2008).
The most widely used measure of trade openness in the empirical literature is
commonly known as the openness index, calculated as (Exports + Imports)/GDP, which is
1

United Nations Comtrade is the pseudonym for United Nations Commodity Trade Statistics
Database. It is compiled by the United Nations Statistics Division and contains detailed imports
and exports statistics by commodity and trade partner countries. For more details, please refer to
http://unstats.un.org/unsd/tradekb/Knowledgebase/What-is-UN-COMTRADE.
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a measure of the importance of international trade in the overall economy. However, this
measure is not without controversy and has its own advantages and disadvantages.
This study employs this variable measure because it has certain advantages. First, it is
simple and intuitively appealing; what this measure does is to measure actual trade flows,
and unlike other measure indices that measure openness based on subjective evaluations
of tariffs, and institutional- and economy-specific structural characteristics, the
(Exports + Imports)/GDP index is not contrived, that is, it does not suffer from subjective
inclusion or preclusion of other variables. Second, data are widely available for many
countries over a long period that most empirical studies use it for cross-country studies of
trade and FDI, allowing comparability of our results with previous findings from other
regions. Third, it captures both policy and gravity components and other variables of
trade openness such as language, legal and political differences.
As with all openness measures, (Exports + Imports)/GDP index measure has its own
disadvantages. First, openness of economy is determined by many factors such as trade
barriers, structural characteristics of specific economies and institutional arrangements.
The (Exports + Imports)/GDP index measure in a country is a result of all these factors.
This implies that a large and open trading country may have a relatively small
(Exports + Imports)/GDP and thus be classified as closed economy if it has a relatively large
domestic value added activities that are supported by the domestic market. Thus, it is not
uncommon to observe that open and liberalised countries such as USA, Japan, and China
categorised as close economies. Second, this measure might not reflect actual trade policy
orientation of a certain country; a country can design appropriate open trade policy and
abolishes all trade and nontrade barriers, but still not trade at all, if it is geographically
located far away from the worlds major trading countries; New Zealand is a case in point.
Taking into consideration the drawbacks and limitations of the measure of trade
openness employed here, we further incorporate six widely used measures of openness to
make a thorough investigation on the links as well as direction of causation between trade
and FDI; hence, we will be able to avoid measurement problems. The additional measures
of trade openness that have been used in this paper are provided in Table 1 below. We
Table 1. Measures of trade openness
Measure
Xi
GDPi
Mi
GDPi
1 25
i =25 GDPi
GDPi

RWTI =

Exports trade share (henceforth XGDP) measured as exports divided by GDP, that emphasis Export-led
growth (ELG) hypothesis approach grounded in classical, neoclassical and endogenous growth theory
Adjusted trade share (henceforth LI) is an approach inspired by Li et al. (2004), where M and GDP are
total imports and GDP expressed for each country i for the 25 countries in our sample. As a country
becomes more open, the measure rises to zero. In a completely closed economy, this variable is 1
Is the contribution the country makes to world trade share (henceforth RWTI), given a set of countries
j = {1, 2 . . . 25} where country i j, then country is world trade share is country is relative trade
intensity in our sample; as suggested by Squalli and Wilson (2009)
Import penetration ratio (henceforth XGDP) measured as imports divided by GDP, which argue that the
benefits from openness are more visible in imports of goods and services, capital, institutions and
ideas as put forward in Rodrik (1999)

( X + M )i
100
1
2GDPi

(VV ) 1 z 1 n
i

( M + X )i
(
)
25
j =25 M + X j

Mi
GDPi

max

Definition

Openness and size measure (henceforth OUTLIE) is an alternative measure for handling outliers
originally proposed by Frankel (2000)
The (VI) openness measure is proposed by Ferrieri (2006), which measures country is capacity by Vmax
(expressed as the maximum value of the ratio of trade to GDP across the whole sample group from
1977 to 2009), adjusted for size effect for each country in the whole sample given by z (the share of
each country in samples exports in a given year) and by n (the share of country in samples GDP in a
given year). Vi represents the value of the ratio of total trade (exports plus imports) to GDP for each
country i in each year from 1977 to 2009

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25%
BOSTWANA
GABON
MAURITIUS
NIGERIA
SEYSCHELLES
RSA

20%
15%
10%
5%
0%
-5%
-10%

1980

1985

1990

1995

2000

2005

Figure 1. Observations of the ratio of FDI inflow to GDP, 1977-2009: upper middle-income
countries
construct the variables using data from Africa Development Indicators 2010, compiled
and produced by the World Bank.
(i) Statistical Description of Data For illustrative and analytical understanding of the data
employed in this study, we have divided countries in our sample into three subgroups
(low income, lower middle income and upper middle income)2 to compare changes over
time and observe trends of volatility and correlation for (Exports + Imports)/GDP and
(FDI/GDP) variables. As for the whole sample group, the average (FDI/GDP) is 1.93%;
the maximum ratio is registered at 37.29% for Mauritania in 2005, while the minimum
ratio is 13.51% for Sierra Leone in 1986. The average(FDI/GDP) for upper middleincome and lower middle-income subgroups is 2.54% and 1.98%, respectively, which is
higher than the total average for the whole sample data. On the contrary, the low-income
subgroup has an average of 1.61%, which is lower than the other two subgroups and that
of the whole sample. Moreover, as can be seen from Figs 1 and 2, the two countries
that show the most volatile trend from the whole sample in terms of (FDI/GDP) are,
respectively, Botswana and Swaziland. Both countries experienced consistent ups and
downs time and again throughout the whole period and had their (FDI/GDP) ranges
from 7.74% to over 15% for Botswana, and from 4.72% to 12% for Swaziland. The
(FDI/GDP) for low-income subgroup exhibit more stable trend throughout the whole
period under study than the other two subgroups (Fig. 3).
The average (Exports + Imports)/GDP for the whole sample group is 76.77%; the
minimum ratio registered is 6% for Ghana in 1982, while the maximum ratio stood at

This is according to, and from, World Bank 2012 data based on gross national income per
capita.
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CAMEROON
IVORY_ COAST
LESOTHO
SENEGAL
SUDAN
SWAZILAND

12%

8%

4%

0%

-4%

1980

1985

1990

1995

2000

2005

Figure 2. Observations of the ratio of FDI inflow to GDP, 1977-2009: lower middle-income
countries
BURKINA_ FASO
GAMBIA
KENYA
MALAWI
RWANDA
TOGO
ZIMBABWE

50%

CONGO_ DEMP
GHANA
MADAGASCAR
MAURITANIA
SIERRA_ LEONE
ZAMBIA

40%
30%
20%
10%

20%

0%
-10%

15%

-20%

10%
5%
0%
-5%

1980

1985

1990

1995

2000

2005

Figure 3. Observations of the ratio of FDI inflow to GDP, 1977-2009: low-income countries
Left axis for: Burkina Faso, Congo Democratic Republic, Ghana, Kenya, Madagascar and
Malawi.
Right axis for: Mauritania, Rwanda, Sierra Leone, Zambia and Zimbabwe.
256% for Seychelles in 2008. In addition, Seychelles trend is an outlying observation,
which appears to have consistent and high (Exports + Imports)/GDP far more than
any other country in the sample, especially towards the end of the period of the
study (Fig. 4). This observation also holds for the (FDI/GDP) (Fig. 1). The average
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280%
BOSTWANA
GABON
MAURITIUS
NIGERIA
SEYSCHELLES
RSA

240%
200%
160%
120%
80%
40%
0%

1980

1985

1990

1995

2000

2005

Figure 4. Observations of the ratio of trade inflow to GDP, 1977-2009: upper middleincome countries

(Exports + Imports)/GDP for upper middle-income and lower middle-income subgroups

is 96.69% and 86.61%, respectively, which is higher than the total average for the whole
sample data. On the contrary, the low-income subgroup has an average of 63.02%, which
is lower than the other two subgroups and that of the whole sample (Fig. 6). Moreover,
the (Exports + Imports)/GDP of Swaziland and Lesotho experienced more volatility than
other countries, which happen to be in the lower middle-income subgroup. Moreover,
lower middle-income and upper middle-income countries perform better on
(Exports + Imports)/GDP than low-income countries, which is not surprising, given that
more open economies tend to do well economically.
These data figures show an overall trend of stable movement for the two variables over
the whole period, with few exceptional years where we see large increase and decrease and
divergence between those groups towards the end of the period under study. Moreover, we
observe an increasing trend in the (Exports + Imports)/GDP for the whole sample,
although this increase is not significant. Two notable exceptions in this case are Botswana
and Togo where we observe a decreasing trend on their trade ratio, especially towards the
end of the period of this study (Figs 4 and 5).
To investigate the relationship between FDI and trade openness in sub-Saharan
economies, the panel data employed in our study contain annual observations of
(FDI/GDP)i,t and (Exports + Imports)/GDP in 2000 constant prices where i = 1, L . . . N
represents the country i and t = 1, L . . . T represents the time-series dimension. To obtain
the observations as much as possible for a balanced panel data, we get N = 25 and T = 33
year period from 1977 to 2009. Moreover, variables are in logarithm form. Further
information on the definition of variables and data sources is provided in Appendix A.
Data availability and geographical coverage compromising sub-Saharan Africa
determined countries in the sample. Appendix B lists countries in our sample.
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240%

413

CAMEROON
IVORY_ COAST
LESOTHO
SENEGAL
SUDAN
SWAZILAND

200%

160%

120%

80%

40%

0%

1980

1985

1990

1995

2000

2005

Figure 5. Observations of the ratio of trade inflow to GDP, 1977-2009: lower middle-income
countries
160%
120%
80%
40%

160%

0%

120%
80%
40%
0%

1980

1985

BURKINA_FASO
GHANA
MALAWI
SIERRA_LEONE
ZIMBABWE

1990

1995

CONGO_DEM
KENYA
MAURITANIA
TOGO

2000

2005

GAMBIA
MADAGASCAR
RWANDA
ZAMBIA

Figure 6. Observations of the ratio of trade inflow to GDP, 1977-2009: low-income countries
Left axis for: Burkina Faso, Congo Democratic Republic, Ghana, Kenya, Madagascar and
Malawi.
Right axis for: Mauritania, Rwanda, Sierra Leone, Zambia and Zimbabwe.

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4.2 Panel Granger Noncausality Test

Dumitrescu and Hurlin (2012) propose a simple Granger noncausality test for
heterogeneous panel data. Under the null hypothesis of homogeneous noncausality
(HNC), there is no causal relationship for any of the cross-section units of the panel.
Consider the following linear model:
k

yi ,t = i + i k yi ,t k + i k xi ,t k + ei .t
( )

k =1

( )

(1)

k =1

where y and x are stationary variables observed for N individuals on T period. K denotes
the lag orders for all N, where the autoregressive parameters, i k and the regression
coefficient slopes, i k are assumed to differ across units; i,t is the residuals for each cross
section unit i.
According to Dumitrescu and Hurlin (2012), we can test the HNC hypothesis by
taking into account both the heterogeneity of the regression model and that of the causal
relation. The heterogeneity of the regression model refers to the slope of the parameters
and the lag orders of individuals that might be different; this is taken into consideration
because such kind of heterogeneity can directly affect the results with respect to causality
relationship. The heterogeneity of the causal relation refers to and implies that it is not
necessary that all individuals have or have not the Granger causality. In other words, it is
possible that some individuals have Granger causality while others have not. Under the
alternative, we hence allow for a subgroup of individuals for which there is no causality
relation and a subgroup of individuals for which the variable x Granger causes y. Then the
null hypothesis of HNC is defined as:
( )

( )

H o : i = 0 i = 1, L N

(2)

where, i = (i 1 , L, i k ), which may differ across groups under the alternative. Under
the alternative H1 there are N1 < N individual processes with no causality from x to y, that
is to say we can observe noncausality for some units under the alternative:
( )

( )

H1 : i = 0 i = 1, L N
i 0 i = N 1 + 1, L N
where, N1 is unknown but satisfies for condition 0

(3)

N1
< 1. Then Z NHnc,T statistic is
N

defined as

Z NHnc,T =

N
(W NHnc
,T K ) d
N (0, 1)
2K

(4)

N
where, W NHnc
,T = (1 N ) i =1 Wi ,T and Wi,T denotes the individual Wald statistics for the i-th
cross-section unit corresponding to the individual test H0 : i = 0.
In recent literature, increasing attention has been paid to error cross-section
dependence (CD) in panel data models. Because if the assumption of cross-section
independence in panel data models is violated, sever size distortions, biased and
inconsistent estimates, and most importantly spurious statistical inference occurs (e.g.

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415

Andrews, 2005; Banerjee et al., 2004). Thus, we need to assess whether the units in the
panel are cross-section dependent because the countries in our sample are located in the
same region and may be exposed to common shocks, such as oil prices, same climate and
culture, and economic and political interactions. Hence, the presence of CD can be
expected among the units of the panel.
Initially, we assess whether the units in the panel are cross-section dependent by
applying CD test proposed by Pesaran (2004). If we find evidence of cross-sectional
dependence on the data, then we apply the MP test (Moon and Perron, 2004) and CIPS
test (Pesaran, 2007) to test for panel unit root, where both tests take into account the
presence of CD.
Having presented our econometric approach, data and variables used, we now turn to
the results of our empirical analysis, looking first at the Granger causality tests, second at
our cross section dependence investigation, and third at panel unit root tests.
5. EMPIRICAL RESULTS

CD test proposed by Pesaran (2004) strongly indicate the presence of CD across the units
(see Table 2). Panel unit root tests proposed by Moon and Perron (2004) and Pesaran
(2007) accept the stationarity for both variables (see Tables 3 and 4).
Next, we employ a simple noncausality test for heterogeneous panel data proposed by
Dumitrescu and Hurlin (2012) to investigate the causal link as well as direction of
Table 2. CD test
FDI/GDP
Trade/GDP

CD(0)

CD(1)

CD(2)

CD(3)

CD(4)

CD(5)

3.85
6.84

3.99
6.35

3.15
5.57

3.08
5.98

2.75
6.41

2.00
6.14

Notes: Under the null hypothesis of cross-section independence, the CD statistic converges to N
(0,1); the null is rejected if |CD| 1.96. CD(P) is the CD value based on the OLS residuals from
the AR(P) regressions for FDI/GDP or Trade/GDP.

Table 3. MP tests for different numbers of factors

FDI/GDP
Trade/GDP

t a*
tb*
t a*
tb*

K=1

K=2

K=3

K=4

K=5

6.708
3.991
4.700
4.113

18.273
14.628
6.547
5.764

17.280
13.124
7.756
6.789

14.317
10.299
6.915
5.979

15.079
10.986
6.233
5.344

Notes: Under the null hypothesis of unit root, the MP statistics are standard normal for large T.
For FDI/GDP, the MP statistics is a case with an intercept and a linear trend, and for Trade/GDP,
a case with only an intercept case.

Table 4. CIPS test

FDI/GDP
Trade/GDP

CADF(0)

CADF(1)

CADF(2)

CADF(3)

CADF(4)

CADF(5)

3.577*
2.927*

3.094*
2.912*

2.03
2.549*

1.853
2.613*

1.615
2.347*

1.462
2.387*

Notes: The 5% critical values for the CIPS statistics are 2.72 and 2.65 for N = 20, T = 30 and
N = 30, T = 50, respectively, with an intercept and a linear trend case, and 2.15 and 2.11 with
only an intercept case. For FDI/GDP, the CIPS statistics is a case with an intercept and a linear
trend, and for Trade/GDP, a case with only an intercept case.
* Signifies that the test is significant at the 5% level.
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Table 5. Tests for panel Granger noncausality

FDI/GDP does not Granger cause
Trade/GDP
Trade/GDP does not Granger
cause FDI/GDP

K=1

K=2

4.2077
(0.0000)
1.6125
(0.1068)

6.2811
(0.0000)
5.4537
(0.0000)

Note: For large N and T samples, the Z NHnc,T

statistic is asymptotic normality. The values in
parentheses are P-values.

causation between trade openness and FDI in sub-Saharan economies. The results for
Granger noncausality tests for two period lags, K = 1 and K = 2, are presented in Table 5.
Granger test results show that the null hypothesis of FDI does not Granger cause trade
and Trade does not Granger cause FDI is rejected at the 1% significance level for both
cases. Thus, our empirical findings indicate that there is bidirectional Granger causality
between FDI and trade openness in sub-Saharan African countries, implying that an
increase in one variable leads to an increase in the other variable.
Nevertheless, it is worth mentioning that, according to the construction of the test
procedure, the rejection of the null hypothesis of no Granger cause does not mean that
every country has Granger cause. Putting it differently, the null hypothesis of HNC is that
no country has Granger cause, while the alternative is that at least one country has Granger
cause. Therefore, to reject the null hypothesis of HNC and accept the alternative means
that at least one country has the Granger cause. However, this does not necessarily imply
that all countries have Granger cause. The conventional view of the theoretical arguments
on the relationship between trade and FDI suggest that, while there are general similarities
between groups of countries, every county is distinctive and the impact and relationship
between trade and FDI depends, among other things, on the idiosyncratic nature of a
countrys resource endowments, macroeconomic policies and institutional set-ups. In
other words, similar group of countries may not exhibit homogenous characters.
This notion is further supported by empirical studies of bidirectional causality
relationship in a co-integration framework for African countries (Bende-Nabende, 2002),
in a bivariate heterogeneous panel dataset for European countries (Chiappini, 2011) and
for Latin American countries (Cuadros et al., 2004). Furthermore, recent studies have
identified four types of FDI flows: in manufacturing industries, infrastructure, extractive
industries and services. These flows are different in nature and likewise determine the
relationship between trade and FDI in different ways (Moran, 2011). Concurrently,
further empirical analysis with disaggregate data on FDI flows (manufacturing,
infrastructure, extractive and services) and trade for African region is required to further
understand the causality relationship between trade and FDI for the region.
Furthermore, we use six additional measures of openness to examine whether our
results are replicable. Using six additional widely used measures of openness along with
the commonly used measure of openness applied in this study, our results provide strong
empirical evidence for bidirectional causal relationship between FDI and trade openness
in sub-Saharan economies. In five out of the seven variables used to measure openness,
our results indicate the presence of bidirectional causality between trade openness and
FDI at the 1% significance level in all of the cases. More specifically, EXPORTS +
IMPORTS/GDP, XGDP, LI, RWTI and MGDP have bidirectional causality while
OUTLIE and VI exhibit unidirectional causality. Furthermore, our findings also suggest
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417

that caution should be exercised when considering the use of openness measures because
there is no single perfect measure that captures the multifaceted nature of trade openness,
as the existing literature claimed. Hence, various openness measures where each variable
measure captures a different facet of openness can be used to get a more precise picture
of the relationship between FDI and trade openness. A similar finding is observed for
other countries in Asia and Latin America in Liargovas and Skandalis (2012). The
Granger causality test results for the six additional measures of openness used in this study
are provided in Appendix C.
Subsequent to the discussion of our empirical results advanced above, we conclude
with a brief summary remarks and explore the relevant policy implications in the
following section.
6. CONCLUSION

This paper examines the causal relationship between trade openness and FDI for subSaharan African region based on a sample of 25 African countries over the period
1977-2009. To this end, the present paper took advantage of recent development in
econometric testing techniques for Granger noncausality in heterogeneous panels that
takes into consideration the effects of cross section dependence across the units of the
panel dataset. Our empirical results indicate bidirectional causality between trade and
FDI for sub-Saharan economies.
The findings of this paper support the predictions from the theoretical models of the
stages-based evolutionary paths of comparative advantage and FDI proposed by Kojima
and Ozawa (1984) and Ozawa (1992), further elaborated in the investment development
path by Dunning and Narula (1996) and Porters (1990) stage-based competitive
advantage of nations, which argued that trade and investment complement each other in
factor driven economies at the early stage of economic development.
The conventional view of these models suggest that countries at the early stage of
economic development attract factor-seeking inward FDI (resources seeking or labour
seeking) destined for exports; this notion is further developed by general equilibrium
models in Helpman (1984) and Helpman and Krugman (1985) based on
HeckscherOhlin trade theory that predict multinational firms to engage in vertical
type FDI in those countries to take advantage of factor proportion where FDI is thought
to complement trade. Furthermore, our results does support previous empirical studies
conducted for African countries that observed complementary relationship between trade
and FDI, among others Asiedu (2002), Onyeiwu and Shrestha (2004) and
Tandrayen-Ragoobur (2011). Moreover, similar results are also found in Liargovas and
Skandalis (2012) for other developing countries, Stone and Jeon (2000) for Asia-Pacific
countries and Ghosh (2007) for emerging Latin American and Asian countries.
Concurrently, addressing key priority areas for trade and FDI strategies are of direct
relevance for this study because of the existence of double causality between the two. In
light of this, we argue that the promotion of FDI strategies has to become a key priority
in the African case because FDI can exert a multiplier effect on trade by addressing
supply-side constraints and expanding the productive capacity to produce and export. It
is a well-known fact that neither lack of trade opportunities nor trade barriers are critical
factors in the dismissal performance of Africas share in the global trade and FDI flows.
The main reason is the lack of productive capacity base of African economies to produce
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and export competitive and international standard-quality products that can compete in
world markets (UNIDO, 2007).
Furthermore, lack of competitive productive supply capacities constrain many African
countries from producing standard-quality products and diversify their exports. Thus,
many African countries depend on single commodity trade for at least 50% of their
international trade (UNCTAD statistical database). Therefore, modernising and
diversifying supply-side capacities is crucial for Africa to integrate into the global trade
and FDI flows, and the best way to achieve this is by increased FDI.
African countries lack human and capital resources, technology and skills to enhance
supply-side capacities. The role of FDI in economic growth is widely documented; in this
regard FDI not only can expand the productive base of African countries to produce
and export, but can be a main source of technology and capital transfer, and major
driver of human resources development and skills. Thus, Africa needs to develop the
infrastructure, institutions and instruments that promote and facilitate FDI to enhance
supply-side capacities and realise the full potential of trade in Africa. In this way, FDI can
contribute to trade-multiplication effect. At the same time, bidirectional causality
indicates that both FDI and trade are connected; thus, countries that desire to attract FDI
should pursue open and export oriented trade policies. Moreover, we recognise the fact
that each individual country is unique, and hence further empirical research at the
disaggregate level is required to reveal complex patterns of trade and FDI for countryspecific or even industry-specific sectors to design more appropriate policy measures
consistent with those characteristics.
Further steps should be taken to deepen regional and interregional economic integration
in Africa that encompasses the establishment of free trade agreements (FTAs) to foster trade
and FDI flows. FTAs are increasingly becoming an important policy tool to foster both
trade and FDI given the fact that FTA rules (tariffs, nontariff barriers to trade and rules of
origin) nowadays directly correspond to FDI agreements (UNCTAD, 2009). FTAs, by
removing trade barrier between member states, are designed to create enlarged regional
markets with free and unrestricted movement of goods services. The removal of trade
barriers further boosts economic integration by increasing the flow of traded goods and
services, which generates faster growth and more income for member states.
Economic integration that arises from FTA will have direct impact on FDI flows to
the African region in various ways. First, by creating an enlarged regional market, an
FTA provides incentives for firms to take advantage of economies of scale in
production, leading to more FDI flows. Second, it is well documented that investors
want a predictable trade, and macroeconomic and investment regimes, and the
establishment of FTA enhances predictability and transparency because individual
member states are locked to adhere to FTA rules. Third, the removal of trade barriers
facilities the free movement of intermediate inputs and/or final products between or
among firms, which adds additional incentive for firms to locate production facilitates
into FTA signatory members. Empirical evidence that support complementary
relationship between FTA and FDI is observed for the African region in Jaumotte
(2004). Similar results have also been found in other regions notably Asia-Pacific region
(Thangavelu and Findlay, 2011).
Recent attempts to boost intra-Africa trade and the establishment of a continental free
trade area is definitely a move in the right direction and will have a significant impact on
fostering both trade and FDI flows in the African region.
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APPENDIX A. VARIABLES, DEFINITION AND DATA SOURCES

Variable

Definition

Data source

Foreign direct
investment

Net inflow of investment made with the objective of establishing a long-term relationship or of
lasting interest (10% or more of voting stock) by a resident of one economy in another
economy. It is the sum of equity capital, reinvestment of earnings, other long-term capital
and short-term capital as shown in the balance of payments divided by value of GDP
The sum of exports plus imports of goods and services measured as a share of GDP

Africa Development
Indicators (ADI)

Trade openness

ADI

APPENDIX B. LIST OF COUNTRIES IN THE SAMPLE

Burkina Faso
The Gambia
Kenya
Malawi
Rwanda
Togo
Zimbabwe
Gabon
Niger
South Africa
Cote dIvoire
Senegal
Swaziland

2013 Economic Society of South Africa.

Democratic Republic of Congo

Ghana
Madagascar
Mauritania
Sierra Leone
Zambia
Botswana
Mauritius
Seychelles
Cameroon
Lesotho
Sudan

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APPENDIX C. TESTS FOR PANEL GRANGER NONCAUSALITY

Table C1. Granger noncausality test for XGDP

FDI/GDP does not Granger cause XGDP
XGDP does not Granger cause FDI/GDP

K=1

K=2

3.505
(0.0005)
3.326
(0.0009)

2.878
(0.004)
1.308
(0.191)

Note: For large N and T samples, the Z NHnc,T statistic is asymptotic normality. The values in
parentheses are P-values.

Table C2. Granger noncausality test for LI

FDI/GDP does not Granger cause LI
LI does not Granger cause FDI/GDP

K=1

K=2

3.904
(0.0001)
6.886
(0.0000)

2.763
(0.0057)
5.866
(0.0000)

Note: For large N and T samples, the Z NHnc,T statistic is asymptotic normality. The values in
parentheses are P-values.

Table C3. Granger noncausality test for RWTI

FDI/GDP does not Granger cause RWTI
RWTI does not Granger cause FDI/GDP

K=1

K=2

2.538
(0.0112)
3.676
(0.0112)

1.859
(0.063)
3.351
(0.0008)

Note: For large N and T samples, the Z NHnc,T statistic is asymptotic normality. The values in
parentheses are P-values.

Table C4. Granger noncausality test for MGDP

FDI/GDP does not Granger cause MGDP
MGDP does not Granger cause FDI/GDP

K=1

K=2

2.308
(0.021)
3.707
(0.0002)

1.603
(0.1089)
2.668
(0.0076)

Note: For large N and T samples, the Z NHnc,T statistic is asymptotic normality. The values in
parentheses are P-values.

Table C5. Granger noncausality test for OUTLIE

FDI/GDP does not Granger cause OUTLIE
OUTLIE does not Granger cause FDI/GDP

K=1

K=2

1.434
(0.1516)
3.763
(0.0002)

0.2072
(0.8359)
1.8
(0.0718)

Note: For large N and T samples, the Z NHnc,T statistic is asymptotic normality. The values in
parentheses are P-values.

Table C6. Granger noncausality test for VI

FDI/GDP does not Granger cause VI
VI does not Granger cause FDI/GDP

K=1

K=2

1.173
(0.2408)
4.498
(0.0000)

0.027
(0.9784)
3.108
(0.0019)

Note: For large N and T samples, the Z NHnc,T statistic is asymptotic normality. The values in
parentheses are P-values.
2013 Economic Society of South Africa.