Measuring the inward FDI potential of South African regions

Abstract

Purpose: The purpose of this paper is to construct an index that captures the factors expected to affect a local economy's attractiveness to foreign investors. Problem statement: Following South Africa's reintegration into the world economy in 1994, foreign direct investment has been seen as a potential driver of growth and development. Concerns about the low investment rate in South Africa raise the possibility of augmenting domestic with foreign investment expenditure. The potential of technology spillovers and skills transfer from foreign direct investment have also been emphasised. As a result, Trade and Investment South Africa is involved in identifying, packaging and promoting investment opportunities. However, investments tend to be place-specific and this has lead to the decentralisation of foreign direct investment promotion. Currently the nine provincial development agencies are competing to attract investors and the larger local governments are also getting involved in the fray. This paper argues that some places have better potential to attract foreign investment than others. A first step to use scarce investment promotion resources more efficiently would be to measure the inward FDI potential of South African regions. Approach: This paper uses principal components analysis to construct an index that captures the factors expected to affect a local economy's attractiveness to foreign investors. This approach draws on UNCTAD's Inward FDI Potential Index and applies it to 354 magisterial districts in South Africa for the periods 1996, 2001 and 2006. The index creates a summary measure of FDI potential. Findings: The results show that different places present differential potential in urbanization and localization economies and market size. The high-potential locations are typically found in or around the major agglomerations, but there are a few smaller places on the periphery that offer FDI potential. Contribution: The index should aid the location decisions of prospective investors as well as local policymakers in their efforts to promote FDI-led economic development. Conclusion: The places with high FDI potential are not randomly scattered across South Africa, but tend to cluster together. Cities and towns can improve their attractiveness to foreign investors through the exploitation of natural resources, population growth, economic growth and strengthening links to metropolitan areas.