Abstract

The study examined the effect of political instability on foreign direct investment of Cameroon. The specific objectives were to access the impact of trade openness on foreign direct investment in Cameroon, to examine the casual relationship between market size and foreign direct investment and to evaluate the impact of inflation on foreign direct investment in Cameroon. This study was backed by Monopolistic Advantage Theory and Resource Based Theory.

The model specifies foreign direct investment measured by Gross Domestic Product as dependent on political instability proxy by trade openness, market size and inflation. Annual time series data from World Bank 1996-2018 was sourced using secondary data and analyzed using ordinary least squared estimation technique.

Results show that political instability has a significant impact on foreign direct investment. Both trade openness and inflation had a significant effect on foreign direct investment of the country while market size had an insignificant effect on the foreign direct investment of the country.

The study therefore recommends that political instability has been detrimental to economic growth and in order to enhance the economic growth in Cameroon, the rate of Political instability need to be reduced to a certain level closer to 0 or 1.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Political instability has been a worldwide problem that plagues many countries in the world especially the less developed with Cameroon being among. Political instability is recognized by economists as a serious disease that is detrimental to economic performance. The widespread occurrence of political instability in several countries over time and its adverse effects on economic performance of these countries has raised the concern of several policy makers (Nazeer & Masih, 2017).

Chawdhury (2016), defines Political instability as the natural tendency of a government to collapse due to due to escalating, sometimes violent, conflicts or infighting between different political parties. Political instability also occurs if there is a rapid change of government and policy, increasing the likelihood of subsequent instability.

Political instability may take many different forms such as: civil-war onset, social unrest, coups d’etat, and transitions to and from democracy. Jong-A-Pin (2009) identifies four dimensions of political instability that can be distinguished: (1) politically motivated violence, (2) mass political violence, (3) instability within the political regime, and (4) instability of the political regime. These have effects on different sectors of the economy such as export, inflation, trade openness, tourism, activity of ports, human rights as well as economic growth (Chawdhury, 2016).

In the same line, Alesina et al. (1996) stated that political instability is the tendency of a government collapse. This may either be due to the conflicts or extensive competition between various political parties. Similarly, the incident of a government change would increase the possibility of successive changes.

There is great consensus from literature that political instability has negative effect on investment, especially foreign direct investment (FDIs) as well as economic growth. Political instability is a great obstacle to foreign direct investment as it gives doubts to foreign investors on the profits they intend to make (Asiedu, 2006).

Foreign direct investment (FDI) is a category of cross border investment in which an investor resident in one economy establishes a lasting interest in and a significant degree of influence over an enterprise which is resident in another country.

Also, FDI can be defined as a process whereby, residents of one country (the source country) acquire ownership of assets in another country (the host county) for the purpose of controlling the production, distribution and other activities of a firm in that country. FDIs bring along financial capital, machinery-equipment, new technology, management skills, manufacturing, and marketing expertise to the host countries (Göçer & Peker, 2014).

Foreign direct investment inflows play an important role in stimulating economic growth. More to that, FDI inflows enhance the transfer of technology, productivity of domestic firms and financial capital needs thereby generating job opportunities and hence economic growth. Political unrest leads to uncertainty that have the effect of forgoing investment opportunities, thus impending economic growth.

Husian (2009) notes that a beneficial business environment relies on political stability of the country. The probable turndown of business activities could result from political risk that comes from a change in government. From this perspective, Root, (1994) provides a detailed analysis, concluding that the success of any contractual business arrangement is systematically related to the political situation. Moreover, Khan and Akbar (2013) argue that uncertainty in the economic environment is directly related to political instability, which in turn negatively affects the foreign investor’s decision

Political instability is likely to shorten policy maker’s horizon leading to suboptimal short term macroeconomics policy. It might also lead to a more frequent switch of policies creating volatility and thus effecting macro-economic performance (Aisen & Vega, 2011). According to Gorge and Greenway (2004) FDI is seen as a key driver of economic growth and development. Most governments consider attracting FDI as a priority, particularly in developing and transition economies. It is given the emphasis not just because it boosts capital formation but also because it can enhance the quality of capital stock.

In general, political instability affects the investment climate negatively which in turn reduces FDI inflows and would lead to slow economic growth. Many developing countries in the world like Cameroon are not politically stable and mostly suffer from poor quality of governance. In this light, the researcher seeks to examine the effects of political instability on foreign direct investment in Cameroon.

1.2 Statement of the Problem

Based on many studies we can understand that, political instability has been a harmful factor that would hinder the flow of FDI and economic growth of a country. Enriching economic instability, political doubt and high geopolitical risks around the world have adversely influenced FDIs; and FDIs decreased by 23% in 2017 with respect to the previous year and realized at 1.43 Trillion USD (UNCTAD, 2018).

More than 50% of these direct investments travelled to developing countries. Brazil, India, and Indonesia still take part in top 20 host economies according to World FDI inflows. FDI to South Africa reduced approximately 41% because of an underperforming commodity sector and political instability. Economies of developing countries deprived of necessary capital and technology gained a positive pace with foreign investments. Yet, the combination of high FDI entered into aforesaid countries and high saving rates resulted in an investment boom in these countries (Baharumshah & Thanoon, 2019).

Specification that most economic fundamentals and transition variables explain FDI flows are unable to answer the question of whether or not the observed FDI flows to transition economies have been abnormally high relative to flows experienced even though the last decades Cameroon has been experiencing increases in FDI, political incentives and significant improvement in the factors governing FDI including economic reform, democratization, privatisation, enduring peace and stability. FDI in Africa generally lag behind those of other regions of the world.

The available evidence seems to point to the fact that Africa has been receiving the lowest share of global FDI over time. Africa’s share of FDI to developing countries declined over time, from about 19% in 1970 to 9% in 1980 and then to 3%  in 1990. It stood at 6.7% in 2002.  Cameroon’s FDI for 2018 was $0.77Billion indicating a 6.06% drop from 2017. In the same vein, Cameroon experienced a decline of by 34.11% in 2020. This work therefore seeks to find out the effects of political instability on FDIs

1.3 Research Question

1.3.1 Main Research Question

What is the effect of political instability on foreign direct investment in Cameroon?

1.3.2 Specific Research Question

The specific research questions include;

1. To what extent does trade openness affect FDI?
2. What is the effect of market size on FDI?
3. How does inflation affect the FDI of Cameroon?

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