Introduction to Empirical Section

Chapter Two: Liberalization, Resource Endowments, and Private Capital Flows in Sub-Saharan Africa

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Chapter Two:

Liberalization, Resource Endowments, and Private Capital Flows in Sub-Saharan Africa


A driving force behind the colonization of sub-Saharan Africa was the search for natural resources, both to feed the industrialization of Europe and to produce armament to fight wars throughout the world. For example, Cecil Rhodes’ British South African Company was founded in 1889 to exploit and colonize south-Central Africa as part of the “scramble for Africa,” with a particular emphasis on mineral extraction. It directly administered Rhodesia (modern-day Zambia and Zimbabwe) until 1923 and only gave up its mineral rights in Zambia in 1964.

Following independence, African states continued to rely heavily on foreign private capital to develop their economies. The volume and nature of these flows varied over time, however (see Figure 1). In the 1960s, the same multinational corporations that played such a prominent role under colonization continued to play an important role. However, the citizens of these newly independent states were not content to let foreigners control their economies. The Father of Ghanaian independence, Dr. Kwame Nkrumah, had said, “Seek ye first the political kingdom and all else shall be added unto you.” Having achieved political independence, Africans expected to control their economies as well.1 Because there were few indigenous private corporations, many governments undertook “Africanization” policies by imposing hiring requirements on private firms, nationalizing foreign enterprises and foreign-controlled mineral and oil reserves, and establishing new state-owned enterprises. But they still relied on foreign finance. Commercial banks, flush with petrodollars from OPEC countries, played a particularly prominent role in the 1970s financing state investment.

ost state-owned enterprises weren’t profitable (Nellis 1994) and by the early 1980s governments were unable to repay their loans. Restricted by government policy from Africa’s private sector and lacking profitable opportunities in its public sector, foreign investors largely left Africa alone from the mid-1980s until the early 1990s. By then, investors were looking for profitable opportunities throughout the developing world. Again, multinational firms returned to Africa, as did investors in new (for Africa) financial opportunities such as portfolio equity and bonds. Although international crises led to a fall in investment for certain years, generally there has been a rise in equity investment (FDI and portfolio) since 1990.
This brief summary of Africa’s economic history vis-à-vis the world economy explains the broad pattern of investment flows to sub-Saharan Africa as a region. But foreign private investors are faced with the decision of which country to invest in, and in what form. Economic factors at the domestic level – such as market size, exploitable natural resources, productivity levels, and the cost of doing business – play an important part in these investors’ decisions. However, domestic political factors also play an important role, in particular investment-related economic policies and the nature of the political institutions. In this chapter, I focus on how these two political factors influence private investment flows to sub-Saharan Africa, including flows to the private sector (including foreign direct investment, portfolio equity, commercial loans, and bonds) and flows to the public sector (commercial loans and bonds).

I find that investors are motivated by both economic indicators of future profit opportunities (such as natural resource wealth and economic growth) and by political factors such as investment-related economic policies and political institutions, which also affect profit opportunities. Furthermore, the effect of these political factors depends on the nature of the economy. Capitalist policies attracts investment to the private sector, particularly foreign direct investment, and the yield from a shift to capitalist policies is particularly high for countries that are highly dependent on natural resources. On the other hand, capitalist policies reduce investment (or, statist policies increase investment) in the public sector inn countries that are natural resource-dependent countries. As for regime type, democracy attracts investment to the private sector, particularly foreign direct investment, but this is only the case for countries that are not dependent on natural resource endowments. In natural resource-dependent countries, democracy appears to have a negative effect on equity investment.

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