The impact of FDI inflows on economic growth, particularly in the host country, has been heavily discussed in the growth and development literature, with most studies concluding that FDI inflows impact positively on the economic growth of the host country (See, for example, Alabi, 2019; Farole & Winkler, 2014; Isaac & Matthew, 2017; Sung-ming, 2014; Tee et al., 2017; among others). This argument stems from the fact that inward FDI leads to technology and capital transfers and increases the product value chains, leading to higher economies of scale and consequently better economic outcomes in the host country. While there is broader consensus in the literature regarding the positive impact of FDI inflows on growth, the single most important question that still lingers among researchers and policy analysts is, why do some countries attract more FDI inflows than others? Studies on the determinants of FDI inflows concentrate on the macroeconomic variables such as the market size and market potential, with little attention being given to the role played by corporate tax rates and institutional factors in attracting FDI inflows, in most especially developing countries.
Statutory rates of corporate taxes, strict government controls, and restrictions, among others, have fallen over the past decades in developing countries more than in developed countries (Azémar & Delios, 2008; Contractor, 2013; UNCTAD, 2016). Yet still, FDI inflows have continued to fall in recent times (UNCTAD, 2019). For instance, statistics from the World Bank indicate that between 2015 and 2019, the number of FDI inflows to Sub-Saharan African countries will fall from 2.64% in 2015 to 1.73% in 2019. Thus, a whopping 0.91% decline in the inflow of FDI into Sub-Saharan African countries within only 4 years.
However, understanding the impact of corporate tax rates on FDI inflows is very crucial because there is still no clear-cut link between lower corporate tax rates and FDI inflows in developing countries (Azémar & Delios, 2008), particularly in Africa. Are lower corporate tax rates seen by investors as an incentive to invest in one country? Or is it seen as compensation for weak macroeconomic fundamentals? Both theoretical and empirical studies of FDI inflows’ determinants indicate that market-based variables are the most important determinants of FDI inflows. However, few empirical studies (Adamu Braimah et al., 2020; Appiah-Kubi et al., 2021; Azémar & Delios, 2008; Bénassy-Quéré et al., 2005; Bucovetsky & Wilson, 1991) have shown that direct fiscal incentives such as lower corporate tax rates play a much significant role in influencing the inflows of FDI in countries with disadvantages in market-based indicators such as market size and market potentials. Consequently, this study argues famously that corporate tax rates are critical in deriving FDI inflows in the context of African countries.
Moreover, this study contends further that besides the macroeconomic factors and corporate tax rates, institutional factors such as government effectiveness; regulatory quality; political stability and absence of violence/terrorism; control of corruption; rule of law; as well as voice and accountability play an important role in foreign investor decisions regarding which location to invest. These macroeconomic or market-based determinants are necessary but not sufficient to explain the cross-country differentials in terms of FDI inflows. This is evident by reports from the United Nations Conference on Trade and Development (UNCTAD, 2016) and the World Bank (2016), which indicate that countries have over the past decades adopted several changes that favor incoming FDI than those that restrict them. Yet, FDI inflows continue to rapidly vary across countries, and this calls for serious attention as to what other factors are accounting for these variations.
The theory of institutional quality provides us with a limited level of understanding as to the role of the quality of institutions in driving the inflows of FDI into a country. This is because previous studies have used either one or a few of the institutional quality indicators to analyze its effects on FDI inflows ( see for examples: Alfaro et al., 2008; Khan et al., 2021; Lu et al., 2014; Pajunen, 2008)). Similarly, the Ownership, Location, Internalization (OLI hereafter) Paradigm or the Eclectic Paradigm propounded by Dunning (1977), which he defined on another occasion in 1988, presents a general framework to identify and evaluate the most important determinants of foreign investment by enterprises and the growth of a foreign investment. The OLI paradigm in its ‘location’ leg underscores the significant role of the peculiarities of the host country, such as its institutions, labor cost, and tariff barriers, in explaining FDI decisions by foreign enterprises or multinational companies (MNEs) (Lundan, 2008).
In particular, empirical studies by (Alguacil et al., 2011; Aziz, 2018; Contractor et al., 2020; Lundan, 2008) conducted over the past reveal that institutional quality plays a greater role in influencing firms’ decisions regarding which countries to invest in. They contend that to attract more FDI inflows, host country governments should develop their local capacities related to the macroeconomic and institutional environment. Thus, host country governments should design several policies that are aimed only at promoting incoming FDI while controlling or improving their political and economic environment. Additionally, Alfaro et al. (2008) used the institutional quality theory to demonstrate that a country receives an extra $79 m as incoming FDI per capita compared to an average country in the world when the country moves up in the institutional quality ranking from the 25th percentile to the 75th percentile. This suggests that the quality of the host country’s institutional environment matters most in MNEs’ decisions as to which country to invest their loadable funds or capital.
Although institutional and macroeconomic theories explain why some countries receive more FDI inflows than others, these theories have not yet accounted for most of the factors accounting for such disparities (Contractor et al., 2020). The theories use only one or a few of the macroeconomic and institutional quality indicators to make a point regarding their significance in determining FDI inflows. These theories failed to capture most of the institutional quality and macroeconomic indicators. Against this backdrop, the current study leverages the institutional quality indicators provided by the World Bank, the ease of doing business, in addition to the host country’s corporate taxation policy to analyze the impacts of these factors on FDI inflows, particularly in Africa.
In all, despite the numerous studies conducted on the FDI-visa-vis-Institutional quality scholarship, few studies both theoretical and empirical explore the nexus between these concepts in developing countries, specifically in the context of Africa. This study, therefore, employs the Generalized Method of Moments (GMM) estimators on data from 2015–2019 for a panel of 50 countries in Africa to examine the role of institutional quality using disaggregated governance indicators, corporate tax rates, and the ease of doing business in determining FDI inflows in Africa.
The rest of this paper is organized as follows: the second section discusses the literature review on the subject matter where the associated theoretical and empirical reviews are analyzed; the third section presents the methods and sources of data; the fourth section looks at the estimation strategy; the fifth section presents the results and discussions, while the sixth and final section presents the conclusion and policy directions.