Evaluating Nigeria and China for FDI - Example

Evaluating Nigeria and China for FDI Introduction Foreign direct investment is affected by a number of factors. Several theories explain why certain countries attract foreign investment while others do not. Political stability, openness are some of the factors that are used to compare the attractiveness of Nigeria and China to foreign direct investment (FDI). The discussion is supported by relevant theories and research in order to effectively compare and contrast the features of Nigerian and Chinese economies that affect the inflows of FDI. Multinational companies consider the factors such as resource availability, local competitiveness and efficiency in making FDI decisions (Dunning, 2008). This paper aims to provide insight to potential investors who are planning to invest in both the Nigerian and Chinese economies. Both the countries have become attractive destinations of FDI in recent years. The Nigerian economy is one of the largest economies in Africa while China is expected to become the largest economy in the world in a few decades. The implications of the discussion of this paper include the commitment of foreign investors to invest in these countries for the long term. Industries Attracting FDI in Nigeria and China Nigeria is an attractive country to invest in as it attracts the maximum amount of foreign investment across Africa. The booming oil industry and growing middle class are significant factors that attract large scale investment to the country. During the period 2001 to 2009, the amount of FDI reaching Nigeria increased from $2.1 billion to $11 billion (Corporate Nigeria, 2009). This has made Nigeria one of the top 20 FDI destinations in the world. The most important industry that receives FDI is the oil industry. Major global companies such as Shell and Exxon have financial as well as operational investments in the country. Out of the contributors of FDI, the leading share is held by South Africa and China who need to invest in the oil industry to satisfy the growing energy needs of their developing economies. It is expected that the oil and gas sector receives three-quarters of the FDI that pours into the country (Corporate Nigeria, 2009). Other than the UK, South Africa and China, other countries such as Brazil and Italy are also investing in the oil and gas sector. There is one major concern for those investing in the oil and gas sector in Nigeria. The sector is a highly lucrative source of revenue for the country and it has put in place certain restrictions on the movement of capital from the sector. While the country allows foreign investors to take back all the profits earned in the country as well as complete ownership of their business ventures, this privilege is not awarded to those investing in the oil and gas industry. The 1995 Nigerian Investment Promotion Commission Act prevents foreign investors from owning the operations (Corporate Nigeria, 2009). This is done because the oil and gas industry is regarded as crucial to the national security of the country. As the second largest economy in the world, China has also become the favourite destination of foreign direct investment. It is expected to overtake the economy of the United States to become the largest economy of the world in a matter of decades. It has already surpassed the Japanese economy and has not been adversely affected by the economic downturn. FDI in 2013 increased by 5.77% compared to the previous year alone (BBC, 2013). In the recent years, given the economic stagnation in US and Europe, the main sources of FDI to China, there have been measures taken by the Chinese government and investment bodies to encourage FDI over the long term. In this regard, new sectors are being developed in order to attract FDI. Traditionally, the main sectors of FDI in China have been the low-end manufacturing industry because of the attraction of low labour costs. However, new investors may direct investment towards high value-added manufacturing sectors as well as in the service sector (China Briefing, 2013). China is also taking steps to attract foreign investment in the technology sector. China is primarily an agricultural country and the agricultural sector plays an important role in the economy (Islam, 2002). With the growing population and rising living standards, the pressure on the productivity of the agricultural sector has been considerable. China is also attracting foreign investment to develop its agricultural base along the lines of modern agriculture (China Briefing, 2013). In addition, foreign investors can also invest in the rapidly developing energy sector as China continues to seek new ways of meeting its energy requirements through conventional as well as non-conventional sources of energy (China Briefing, 2013). Political Environment for FDI in Nigeria and China Political stability and reform are an important determinant of FDI to any country. Nigeria is in a sensitive position with regard to political stability and freedom. The reason for this is the wide diversity across the country and the lack of efforts at building political cohesion in the country. Nigeria is a fragmented and multi-cultural society. More than 250 ethnic groups exist in the country with frequent competition for political power. Religious differences also create friction between the Muslim north and the Christian south. The political climate thus becomes unstable due to the competition between rival factions for political power. In recent years, the political stability in Nigeria has been further put at risk with the growing assertiveness of Islamist groups such as the Boko Haram. These groups have carried out acts of terrorism and violence in the country and have targeted the energy industry which is a serious concern for foreign investors (Portnoy, 2012). Political stability has also played a major role in making China the most attractive destination of FDI in the world (Backman, 2007). There has not been a major political upheaval in the country since the Tiananmen Square massacre more than two decades ago. Since then, despite criticism against the one-party rule in the country, investors have continued to direct their funds to the country because of the relative stability of the political regime compared to other countries. Recently, the political regime has become more flexible with the opening up of its economy to foreign investment. Interest Rates and Exchange Rates in Nigeria and China Oladipo (2013) conducted a research study on the determinants of FDI into Nigeria based on data for the period 1988 to 2010. On the basis of the data and accompanying analysis he concluded that as the interest rates in Nigeria increased, there was a reported decline in the level of foreign direct investment. He argues that rising interest rates in Nigeria have led to an increase in foreign investment in recent years. Omankhanlen (2011) has conducted a study on the effect of interest rates on the level of FDI in Nigeria. He explains that the exchange rate has been a strong determinant of FDI inflows into the Nigerian economy. The rising levels of FDI in the country can be explained partially by the strengthening position of the Nigerian Naira. China has also been increasing interest rates and raising the level of cash reserves at commercial banks to increase FDI inflows to the country (Bloomberg, 2011). Liu (2010) conducted a study on the determinants of FDI inflows to China and concluded that MNC’s are attracted to invest in China because of the lower lending rates in comparison. The high rates of interest in China encourage MNCs to source investing from the home country and invest those in China (Backman, 2007). Oladipo (2013) also states that the exchange rate is a major determinant of the FDI inflow into China. He argues that the Generalized Method of Moment estimation shows that exchange rate is one of the largest determinants of FDI. Resource Costs in Nigeria and China Resource costs play an important role in directing foreign investment to a country. It is reported that Nigeria has the second largest oil and gas reserves in Africa. This makes it an attractive destination for foreign direct investment because of the low cost of fuel and energy. Secondly, Nigeria is a developing country with low costs of manpower. Hence, the combination of low energy and labour costs is attractive to foreign investors. The existence of natural resources in the form of oil and minerals have attracted investment in the oil and mining sectors whereas the manufacturing sector has received investment because of low wage levels. This shows that foreign investors are attracted by the lower resource costs and natural resources of the country. Low labour costs are a conventional advantage for China which has helped the country to attract considerable foreign investment into its low-cost manufacturing sector (Backman, 2007). According to Ali and Guo (2005), China’s industrial added value is supported by foreign investment up to 28%. However, there is also the accompanying concern for the productivity of the labour force and the quality of the infrastructure which can considerably overshadow the gains made by lower resource costs. Industries benefitting from the low resource costs of the country include the automobile industry and the telecommunication equipment industry. With the decline in the automobile industry and consumer spending, China’s low labour costs enable automobile manufacturers to maintain their profitably at low price levels. Role of Market Size in FDI in Nigeria and China Nigeria has one of the largest economies in Africa which is demonstrated by its GDP. Consequently, the growing GDP is an indicator of market size which attracts investment from foreign sources. It is one of the leading African nations to receive foreign investment. However, there is a growing need to increase FDI to make it proportionate to the amount of resources and market size of the country. It has also been suggested that a cyclical relationship exists with market size attracting FDI which in turn results in an increase in the size of the economy (Ayanwale, 2007). The GDP of Nigeria has been growing consistently since 2000 and was $451 billion in 2012. In 2012, the GDP grew by an estimated 7.1% in which agriculture and the service industry played an important role. The size of the Chinese market has been one of the strongest reasons for its attracting FDI from around the world (Islam, 2002). The Chinese market exceeds 1 billion consumers and is the single largest national market. The size of the economy is only second to the United States and stands at $8 trillion. A rapidly growing middle class means that consumer demand is likely to grow in the coming years. GDP growth rate in 2012 was 7.8% which was slightly more than the growth shown by the Nigerian economy. Demand in the agricultural, energy and telecommunications sector is growing rapidly with the country becoming the largest importer and exporter of consumer goods. Competition and Openness in Nigerian and Chinese Economies Openness is directly related to economic growth in Nigeria. A study by Nduka (2013) shows that openness in the economy contributes directly and positively to economic growth. It has been shown that liberalization of manufacturing and service sectors can lead to even greater economic growth by attracting foreign investment. However, in terms of competition, the Nigerian economy fares rather poorly. It is on the 120th position of the Global Competitiveness Index which is a poorer performance compared to the previous year in 2012 when it was on the 115th position (All Africa, 2013). Mainly because of the dependence on resource factors to help the economy grow, the country has not been able to develop the policies and institutions to foster competitiveness in the economy. In terms of openness and competition, the Chinese economy performs impressively. According to Lardy (2007), most sectors of the Chinese economy are competitive as are the markets for various goods and services. The Chinese economy also reflects a great degree of openness which can be evidenced by the growing number of imported goods and services. Large as well as small markets reflect a mix of imported and locally manufactured goods. As a result, the price levels in China reflect international prices levels. This is a positive stimulus to FDI as it encourages foreign companies to set up joint ventures and subsidiaries in the country. This helps the country to increase its economic output and attract more FDI (Lardy, 2007). Innovation and Technological Diffusion in Nigeria and China Foreign competition has encouraged the Nigerian economy to pursue the adoption of technology and innovation to boost its productivity. Many firms in Nigeria now pursue internationally recognized quality certifications and adopt ICT into their operations. Through such measures, domestic firms have become more competitive with international firms. At the same time, this has also encouraged international firms to seek supply linkages with firms in Nigeria. The Nigerian economy is moving from a dependence on primary commodities to value-added manufacturing (Ola-David and Oyeyinka, 2012). Hence, automation and technology play an important role in this development. Most manufacturing companies in Nigeria belong to the small and medium sector. As a result, they do not possess the required economies of scale or scope to benefit from automation and ICT-integrated processes. The Nigerian economy is now being characterized by a growing number of linkages between manufacturing firms in the small and medium sector with universities and research institutions to develop ways in which these firms can adopt automation and process automation to increase their production capacity. At the same time, efforts are being undertaken to prevent significant loss of jobs for the workforce (Ola-David and Oyeyinka, 2012). This is being achieved partially by worker training programs and education. There is also a growing awareness for programs to develop entrepreneurs who can participate in the diffusion of ICT and technology in the industry. This is an attractive investment opportunity for foreign investors as they can participate in the technology diffusion process by setting up joint ventures and collaborations with local firms. In China, the online economy plays a growing role in the economy (Wang, 2012). E-commerce has developed rapidly over the past few years spurred on by the rising consumption levels of China’s middle class consumers. Specific websites have emerged that cater to the consumer-to-consumer segment as well as the business-to-consumer segment. The potential of the online economy is likely to grow. Hence, it is an attractive opportunity for foreign investment in this area. It should be noted that understanding of local norms and the local competitive environment is vital for success in the e-commerce economy. China has a unique political, cultural and social environment. These aspects should be considered when developing any strategy for entering the Chinese market (Wang, 2012). The rapidly growing e-commerce economy can be divided into its technical and non-technical aspects. The e-commerce economy in China has relatively low barriers to entry as the technology platforms are more or less the same as in other parts of the world. However, as the entry barriers are reduced, the companies compete on how well they understand consumers and can provide value to them through the online economy business model. Thus, firms entering the Chinese online economy should take their time to understand local customs, norms and the business environment. Technology diffusion in China takes place at a rapid pace, which means that the window of opportunity during which a foreign firm can use its competitive advantage is limited. Chinese firms who follow foreign companies can benefit from their understanding of the local market despite having caught up to the technical innovation at a later stage (Wang, 2012). Positive Aspects of Investing in Nigeria and China Several factors can be cited in favour of investing in China and Nigeria. The two countries are among the highest recipients of FDI in recent times and are experiencing consistent economic growth for the past several years. The Chinese economy has grown at the average rate of 10% each year over the past decade while the Nigerian economy is one of the most dynamic ones in Africa. The two countries are also situated in areas where the entire region is experiencing economic growth. For instance, in addition countries such as South Korea and Vietnam are also benefiting from FDI, not to mention India. Similarly, countries such as Tanzania and Mozambique in Africa have also been receiving FDI inflows in recent years. Both the economies are making steps towards diversification and automation, although China has made considerable progress over Nigeria in this regard. Nonetheless, Nigeria may also make considerable progress if supported by adequate political and economic reforms. The interest rates and exchange rates of the two countries also make them highly attractive for foreign investors. High interest rates for commercial lending are being maintained in both the countries which makes it more attractive for foreign investors to borrow from their home countries and invest in the host countries. However, when deciding to invest in these countries, it is important to consider factors such as geographical and cultural proximity to the home country. These factors may influence the decision about investing in either one or both the countries under discussion. Negative Aspects of Investing in Nigeria and China Despite the positive features of the two economies that make it them an attractive destination for FDI, there are some negative aspects too that should be kept in mind when making investment decisions. The first is the lack of diversification in the Nigerian economy. This is an important weakness because it limits the scope for technological innovation and automation that has enabled firms in developed countries to achieve economies of scale and greater efficiency. This weakness is based on political systems and economic policies that have failed to accelerate the pace of economic development from a resource-based economy to an industrial or service based economy. Firms that do not possess expertise in resource-based economies would not prefer to invest resources in the Nigerian economy which is dominated by the oil and gas sector and the agricultural sector. A concern with the Chinese economy is the political risk that exists because of the one-party system based on communist principles. Other factors that shape political risk include the growing interference of the government in economic affairs (Peng, 2011). This increases the risk that the resources of the investing firm may be usurped or nationalized by the government. At the same time, the rising income levels in the Chinese economy may soon eliminate the low cost of labour which has attracted FDI for the past several years to the Chinese manufacturing sector. However, the growth in the service sector is impressive and international investors may be more interested in diversifying their investments in this sector. where The above discussion shows that both the Chinese and Nigerian economies possess positive Conclusion The above discussion shows that both the Chinese and Nigerian economies possess positive as well as negative features. Both countries are good destinations for FDI as they have been showing growth and diversification. As the western economies experience stagnation, the investors are eyeing these economies for investment. However, the Chinese economy is clearly a better option because of the stronger institutions and policies that favour openness and competitiveness. Compared to Nigeria, China also has a higher level of technological diffusion and innovation. Efforts are being undertaken in Nigeria to promote technological innovation. However, this has not matched with the performance of the Chinese economy. Secondly, the Nigerian economy is mainly dominated by primary sectors such as agriculture, mining and oil extraction while the Chinese economy is rapidly progressing in its value-added manufacturing and service industries. Therefore, foreign investors’ decision to invest in these countries would be affected by the kind of portfolio diversification they are seeking. References Ali, S., Guo, W. (2013). Determinants of FDI in China. [Online]. Available from: . [Accessed on 29 December 2013]. All-Africa. (2013). Nigeria ranked among world’s poorest competitive countries. [Online]. Available from: < http://allafrica.com/stories/201309050324.html>. [Accessed on 29 December 2013]. Ayanwale, A. B. (2007). FDI and economic growth: Evidence from Nigeria. [Online]. Available from: . [Accessed on 29 December 2013]. Backman, M. (2007). Big in Asia, 2nd ed.. Palgrave Macmillan. Islam, I. (2002). Asia–Pacific Economies, Routledge Publishing. BBC News. (2013). Foreign investment in China up 5.8% in first 10 months. [Online]. Available from: . [Accessed on 29 December 2013]. Bloomberg. (2011). Foreign direct investment in China in 2010 rises to record $105.7 billion. [Online]. Available from: . [Accessed on 29 December 2013]. China Briefing. (2013). China releases guiding opinions on attracting foreign investment. [Online]. Available from: . [Accessed on 29 December 2013]. Corporate Nigeria. (2009). FDI Overview. [Online]. Available from: . [Accessed on 29 December 2013]. Dunning, J. (2008). Multinational enterprises and the global Economy. Edward Elgar Publishing. Lardy, N. R. (2007). China’s economy: Problems and prospects. FPRI. [Online]. Available from: . [Accessed on 29 December 2013]. Liu, W. (2010). Determinants of FDI inflows to China. Taipei International Conference on Growth, Trade and Dynamics. [Online]. Available from: . [Accessed on 29 December 2013]. Nduka, E. K. (2013). Openness and economic growth in Nigeria. Journal of Education and Practice. 4(1), pp. 68-73. Ola-David, O. A., and Oyelaran-Oyeyinka, O. (2012). Can FDI foster inclusive innovation and technology development in Africa? [Online]. Available from: . [Accessed on 29 December 2013]. Oladipo, O. S. (2013). Macroeconomic Determinant of Foreign Direct Investment in Nigeria. [Online]. Available from: . [Accessed on 29 December 2013]. Omankhanlen, A. E. (2011). The effect of exchange ate and inflation on foreign direct investment and its relationship with economic growth in Nigeria. University of Galati. [Online]. Available from: . [Accessed on 29 December 2013]. Peng, M. W. (2011). International Business. South-Western Higher Education. Portnoy, E. (2012). Foreign direct investment in Nigeria. [Online]. Available from: . [Accessed on 29 December 2013]. Read More