The Evolution of FDI in Mozambique: Policy and

Economic Effects

Damiao Cardoso∗

October 15, 2010

Abstract

During the past few decades, the competition for foreign direct in-
vestments (FDI) has increased around the world. Taking a closer look
at Mozambique, this paper examines policies used to attract FDI and
some of the effects FDI has had on the Mozambican economy over
the period 1960 - 2007, both from theoretical and empirical point of
view. Data from International Financial Statistics Year Book and the
World Development Indicators of the World Bank were used to estimate
an OLS regression model explaining determinants of FDI in the
country. It is found that market size, export orientation (Openness) and
Liberalization have a significant positive impact on FDI while
macroeconomic instability and low level physical infrastructure have a
negative impact on FDI. These findings imply that liberalization of the
trade and regulatory regimes, stable macroeconomic and political
environment, and major improvements in infrastructure is required to
improve the level of private and FDI to Mozambique.

Key words: Foreign Direct Investment, Mozambique.

JEL Classification: F21, O55, C22

∗
Department of Economics and Institutions, University of Rome “Tor-Vergata”. Via
Columbia 2, 00133 Rome (Italy) E-mail: damiao.cardoso@uniroma2.it

1
1 Introduction

One of the notable features of economic globalization is the increased flows

of Foreign Direct Investment (FDI) around the world. Over the last decades,
FDI flows have grown twice as fast as trade. The rapid growth in FDI over the
last few decades has spurred a large body of empirical literature to examine
the determinants and the growth enhancing effects of FDI.
FDI is often seen as an engine for economic growth and development. It
is particularly important for developing countries since it provides access to
resources that would otherwise be unavailable to these countries. Its
contribution to economic development and therefore poverty reduction comes
through its role as conduit for:

• Transferring advanced technology and managerial and organizational

know- how to the host country;

• Helping to create a more competitive business environment;

• Triggering technological and other spillover to domestically owned enter-

prises;

• Contributing to international trade integration; and

• Assisting human capital formation.

As result of these benefits of FDI, many developing countries, including Mozam-

bique, are now actively seeking foreign investments by taking measures that
include economic and political reforms designed to improve their investment
environment in order to attract investments from multinational corporations
(MNCs).1 The favorable treatment towards foreign companies is motivated by
the belief that the presence of MNCs will not only attract foreign capital to
the host country, but also increase employment, exports and competition and
thereafter economic growth although, as noted by Asiedu (2006), that increased
FDI does not necessarily imply higher economic growth. Indeed, the empirical
(UNCTAD, 1999).
1

2
relationship between FDI and growth is unclear. 2 Some studies have found a
positive relationship between FDI and growth (De Gregorio, 1992; Oliva and
Rivera-Batiz, 2002). Other studies conclude that FDI enhances growth only
under certain condition - when the host country’s education exceeds a
certain threshold (Borenzstein et al, 1998); when domestic and foreign capital are
com- plements (De Mello, 1997); when the country has achieved a certain
level of income (Blomstrom et al, 1994); when the country is open
(Balasubramanyan et al, 1996) and when the host country has a well
developed financial sector (Alfaro et al, 2004). In contrast, Carvokic and
Levine (2002) conclude that the relationship between FDI and growth is not
robust. These studies seem to suggest that for countries in SSA, 3 reaping the
benefits that accrue from FDI, if any, may be more difficult than attracting
FDI. Asiedu states, however, that there is room for optimism. The policies
that promote FDI to Africa also have a direct impact on long term economic
growth. As a consequence, African countries cannot go wrong implementing
such polices (Asiedu, 2006). Following this belief, in recent years, Mozambique
has started encouraging the inflow of FDI by improving the investment
climate and by providing different incentive packages. The challenge for the
Mozambican policy-makers is to direct economic policy to attract increased FDI
which will support the resurgence of the country’s economy.
The objective of this study is twofold: Highlight some of the policies used
by the Mozambican government thought to be essential for attracting FDI to
the country. The second objective of this study is to examine the impact of
the presence of foreign companies on the Mozambican economy. The effect on
employment, production, productivity and exports will be looked at more closely.
The first contribution made by this study is that the literature on the empiri-
cal determinants of FDI flows in Mozambique is scarce. The second contribution
See De Gregorio (2003) and Durham (2000) for a review of the literature on the effect
2

of FDI on growth.
3
Sub Saharan Africa - is a term used to describe the area of the African continent which
lies south of the Sahara, or those African countries which are fully or partially located south
of the Sahara.

3
is the empirical estimation of the selected variables that could influence on
the host country for attracting FDI. An investigation on FDI in Mozambique
applying econometric methods to estimate seems to be the first. The
existing few works on this matter has not directly and fully addressed the
question of FDI-bias against Mozambique using econometric techniques.
The paper proceeds as follows. Section 2 gives the broad overview of the
recent theoretical and empirical literature on FDI. Section 3 outlines the recent
FDI performances and policies in Mozambique. Section 4 provides an exposition
of the data used in the empirical estimation, as well as a discussion of the
econometric techniques being employed. In Section 5 empirical models
specifica- tion is presented. In Section 6 discussion of estimation results and
findings is provided. Main conclusions and policy implications can be found in
Section 7. The complementary material are presented in the Appendices.

2 Literature review

As noted in the introduction, the crucial role of FDI in terms of capital formation,
spillover effects on trade and technological progress has led to the development
of theoretical and empirical literatures which have focused on identifying the
possible determinants of FDI. This section provides a survey of theoretical
and empirical literature on FDI regarding the impact of it on the recipient
economy.

2.1 Theoretical explanations of FDI

The theory of the determinants of private investment, irrespective of whether it

originates domestically or from abroad, is relevant for an understanding of what
drives FDI. The theoretical explanations of FDI largely stem from traditional
theories of international trade that are based on the theory of comparative
advantage and differences in factors endowments between countries. MNCs are
usually attracted to a particular country by the comparative advantage that
the country or region offers. For instance, MNCs may establish foreign
subsidiaries in one country to take advantage so its lower labour costs or its large

4
market size.

5
Nonetheless, the traditional trade theories do not provide full answers as to
why MNCs prefer to operate in a foreign country rather than engaging in
exporting or licensing, which are alternatives to FDI. This has led to the
development of alternative explanations of FDI.
The theory of portfolio investment (the neoclassical financial theory of
portfo- lio flows) is one of the earliest explanations of FDI. The basis of this
explanation lies in interest rate differentials between countries. According to
this theory, capital moves in response to changes in interest rate differentials
between coun- tries/regions and MNCs are simply viewed as arbitrageur of
capital from countries where its return is low to countries where it is high. This
explanation, however, fails to account for the cross movements of capital
between/across countries. In practice, capital moves in both directions
between countries. In addition, that capital is only a complementary factor in
direct investment and that this theory does not explain why firms go abroad
contribute to the criticism of the neoclassical theory of investment (Harrisson et
al, 2000).
Another explanation of FDI worthy of some discussion is the Vernon’s product
life cycle theory. This theory focuses on the role of innovation and
economies of scale in determining trade patterns. It states that FDI is a stage
in the life cycle of a new product from its invention to maturity. A new
product is first manufactured in the home market. When the home market is
saturated, the product is exported to other countries. At later stage, when
the new product reaches maturity and loses its uniqueness, competition from
similar rival products becomes more intense. At this stage producers would
then look for lower cost foreign locations. This theory shows how market
seeking and cost reduction motives of companies lead to FDI. It also explains
the behaviors of MNCs and how they take advantage of different countries
that are at different levels of development. Additionally, it has been noted
that Vernon’s theory, perceives FDI as a defensive strategy by firms to
protect their existing market position (Dunning 1993).
Knickerbocker (1973), following Vernon’s theory argues that firms go abroad
because of oligopolistic reaction which is “an interactive kind of corporate be-

6
havior by which rivals in industries composed of a few large firms counter one
another’s moves by making similar moves themselves”. However this theory
does not explain why FDI is more efficient than exporting or licensing for
expanding abroad.
Hymer (1976) pioneering study on MNCs draws attention to the role of
MNCs as global industrial organization. His major contribution was to shift
attention away from neoclassical financial theory. He argued that the need to
exercise control over operation is the main motive of FDI rather than the mere
flow of capital. Capital is used to facilitate the establishment of FDI rather than
the end in itself. He states that for firms to engage in cross border activities,
they must possess some kind of monopolistic advantages. The advantages result
from a foreign company’s ownership of patents, know-how, managerial skills
and so on and these advantages are unavailable to local companies. His
argument lies on the existence of market imperfections, such as difficulty of
marketing and pricing know-how, or in some cases markets may not exist for
such products, or if they exist, they may involve huge transactions costs or time-
lags. In such cases it would be more efficient for the company to engage in direct
investment than exporting or licensing.
An early attempt to explain the patterns and strategic behavior of MNCs
is the so called electic paradigm or OLI4 theory developed by John
Dunning(see Dunning 1977, 1981). By incorporating Hymer’s explanations and
various other theories of FDI, Dunning’s electic theory provides a general
explanation for the determinants of FDI. According to the OLI theory, the
ownership and internal- ization advantages are firm specific features whilst the
location advantages are country specific characteristics which the host country
can influence directly. Therefore, countries that have location advantages
can attract more FDI. But 4The “O” stands for ownership and refers to competitive
advantages. The “L” stands
for location advantage regarding any characteristics of the host country that makes it more
profitable for the MNC to produce there rather than to produce at home and export to the
foreign market. The “I” stands for internalization, which regards the fact that the MNC will
make a direct investment in a foreign market only if the gains are larger in doing so rather
than reaching the foreign market through licensing, or exporting.

7
firms do not undertake FDI only for the presence of location specific advantages
in the host country. Their location choice decisions consider the profitability
with which the ownership and internalization advantage can be combined with
the location ones. From these three advantages if only one is met, then firms
will rely on exports, licensing or the sale of patent, to service foreign markets.
Economic theory also provides an extension of the OLI paradigm, where
different types of FDI are identified depending on the reasons for the firm to
invest abroad. Dunning (1993) identifies four possible motives for FDI:

• Market-seeking FDI - takes place when the investment aims at penetrating

new markets or maintaining already existing ones. The purpose of this
kind of investment is serving local and regional markets. Host countries’
characteristics that can attract market-seeking FDI include market size of
the host country, per capita income and growth (potential) of the market.

• Resource-seeking FDI - the objective of the investor is to secure access

to low-cost (skilled and unskilled) labour or natural resources and raw
materials. In some cases the aim of the multinational is to acquire
these factors of production at a lower cost than in its country of origin
and sometimes they are not available at all in the home country. This is
often the case with inward FDI to developing countries, where the
foreign firm is frequently seeking national resources or low-cost
labour.

• Efficiency-seeking FDI - investors seeks to reconstruct existing production

through taking advantage of lower cost structure (such as endowments
and government incentives)in the host economy or economies of scale in
the production. Finally,

• Strategic-asset seeking FDI - refers to investment that enables the MNCs

to protect or develop its ownership specific advantage in order to
maintain and enhance the firm international position with less concern
about the particular advantages of specific host country.

These above four motives of FDI are categorized under economic determinants
of FDI.
8
2.2 Empirical evidence on the determinants of FDI

Since the study attempts to analyze policy and economic effects of FDI in
Mozambique, the review of the empirical literature is made to focus largely
on FDI in developing countries in general and Africa in particular. On the
determinants of FDI in Africa, most studies argue that FDI inflows is attracted
largely by natural resource endowments. According to UNCTAD (2008), a
large proportion of the FDI projects launched in the region in 2007, for
instance were linked to the extraction of natural resources. Basu and
Srinivasan (2002), argued that almost 40 percent of FDI in Africa has been in
the primary sector, particularly oil and mineral extraction business. Countries like
Angola, Botswana, Namibia, R.D.Congo, and Nigeria have received foreign
investment targeted at the oil and mineral sectors of their economy.
Morisset (2000) reports that, on the survey conducted on 29 African countries,
there is a high correlation between FDI inflows and total value of natural resources
in each country. Though natural resource abundance is a common factor
explaining much of the FDI inflows, the few successful African countries have
also put particular attention to the creation of favorable economic, social and
political environment for FDI. Other countries, such as Mauritius and
Seychelles have managed to attract FDI by tailoring their FDI policies through
liberalization, export orientation, tax and other investment incentives.
Empirically, Root and Ahmed (1979) analyzed the determinants of non-
extractive direct investment inflows for 70 developing countries over the period
1966-70. Their analysis focuses on testing the significance of the economic, social
and political variables in explaining the determinants of FDI. They conclude
that developing countries that have attracted the most non-extractive FDI
are those that have substantial urbanization, a relatively advanced
infrastructure, comparatively high growth rates in per capita GDP, and
political stability. Asiedu (2002) has also expressed a similar view analyzing
the impact of natural resources, infrastructure and openness to trade on FDI
flows to Sub-Saharan Africa. Her findings indicate that FDI in Africa is not
solely determined by availability of natural resources and that governments can
play an important role

9
in directing FDI through trade reform, macroeconomic and political stability,
efficient institutions and improvement in infrastructure.
Several other studies find that countries that have a higher degree of openness 5
attract more FDI. Singh and Jun (1995) find export orientation (export as
percentage of GDP) to be the strongest factor explaining why a country attracts
FDI. Chakrabarti (2001) finds openness to trade being positively correlated with
FDI. Morisset (2000) finds a positive correlation between trade openness and the
investment climate for 29 African countries. Studying factors that
significantly influence the long-run investment decision-making process of investors
in 19 Sub- Sahara African countries, Bende-Nabende (2002) finds market
growth, export- orientation policy and liberalization as the most dominant long-
run determinants of FDI. Salisu (2003) finds openness to trade having positive
and significant effect on FDI in Nigeria while Tsikata et al (2000) find export-
orientation as a significant determinant FDI inflows to Gana. Asiedu (2002),
using exports and imports as a percentage of GDP to proxy openness comes to
a similar conclusion for Sub-Saharan African host countries.
As mentioned earlier, market size which is usually measured by real per
capita income, plays an important role in attracting FDI, especially market
seeking FDI. However, the empirical evidence for market size as a determinant
of FDI has mixed results. Obwona (2001) finds market size to be a significant
determinant of FDI in Uganda. Agodo (1975), Schneider and Frey (1985),
Morisset (2000), Lemi and Asefa (2001), Chakrabarti (2001), and Lee (2003) are
some of the other studies with evidence in support of the hypothesis that large
market size encourages FDI.
Some other studies argued that macroeconomic stability, government policies
and political variables are more important determinants of FDI in Africa than
the market variables. Schneider and Frey (1985) used politico-economic model
which simultaneously includes economic and political determinants of FDI in
explaining the flow of FDI in 80 less developed countries. They find that the
In most studies openness is measured by the ratio of exports (exports plus imports divided
5

by GDP).

10
most important determinant of FDI is a country’s level of development, measured
by real per capita GNP and balance of payments. The higher the per capita
income and the lower the balance of payments deficit, the higher the amount of
FDI attracted. Regarding the political determinants of FDI, Schneider and Frey
(1985) conclude that political instability significantly reduces the inflow of
FDI. Lemi and Asefa (2001) also arrive at similar conclusions.
Moreover economic factors such as labour, trade connection, size of the
export sector, external debt, and market size of the countries are found to be
significant determinants of FDI flows to African countries. These conclusions
are in line with the findings of Agodo (1975) who finds that the U.S. private
investors’ corporate decisions to undertake manufacturing investment in Africa
are essentially determined by the expected rates of return on investment,
political stability and favorable investment climate, the size of domestic market,
the presence of needed raw materials and infrastructure. Lee (2003) draws
particular attention to the effectiveness of government policies towards FDI
activity. His findings indicate that while a country’s market size and openness to
trade are crucial factors for foreign investment flows, government policies play an
important role to FDI inflows. Corruption is also another key concern of foreign
investors on top of political and policy instability. The WIR (1999) reports that
factors most frequently mentioned by foreign investors in Africa as having a
negative influence on investment are bribery, high administrative cost of doing
business and access to capital. Salisu (2003) analyses the impact of corruption in
Nigeria and finds corruption having a significant detrimental effect on FDI.
Human capital, both in terms of quantity and quality, is another important
factor in promoting labour intensive and export oriented FDI in particular.
Noorbakhsh et al (2001), using secondary school enrollment ratio and the number
of accumulated years of secondary and tertiary education in the working age
population as proxy to human capital, find human capital to be a significant
determinant of FDI inflows from 36 developing countries. Nunnenkanp
(2002) has analyzed globalization-induced changes in the relative importance of FDI
in developing countries and finds that traditional market-related determinants
are

11
still dominant factors but the availability of local skills has become a relevant
pull factor of FDI in the process of globalization. Salisu (2003) also finds low
level of human capital, as measured by the illiteracy rate having a
discouraging effect on FDI in Nigeria.

3 Mozambican’s recent economic and FDI per-

formance and policies

3.1 Historical overview notes of the country

Mozambique gained its independence from Portugal in 1975. The independence

movement, FRELIMO, introduced a socialist system and very ambitious develop-
ment objectives shortly thereafter. A ten-year perspective plan was introduced
in 1977 with the objective to end underdevelopment. The proposed policy
measures were rapid industrialization based on the agricultural surplus that
would emerge from rapid modernization. The state would allocate resources
and coordinate the modernization process (Abrahamsen and Nilsson 1995).
Initially the program was met with considerable success as far as social
indicators were concerned and modest success in economic development;
achieving strong export growth and moderate economic growth. 6
However, the country was soon plunged into a devastating civil war that was
fulled by both local conflicts and the cold war. The war lasted for about two
decades and left the country the poorest in the world when the war came to
an end in 1992. Social, economic and physical infrastructure was devastated
and the economy had largely resorted to subsistence production and barter
trade. In spite of the war, Mozambique introduced an Economic Recovery
Program (ERP) supported by the IMF in 1987. The basic elements of the
program were stabilization of the economy and reforms, notably liberalization of
external and internal trade and privatization.
6
The annual average growth rate was about 2.8 % during the period 1977-81, while exports
grew by 15 % annually during the same period. The number of teachers doubled, the illiteracy
rate declined from 93% to 70 % and health indicators improved substantially.

12
 The first free elections were held in 1994, and the newly elected
president and government soon embarked on a comprehensive recovery
program, which can be seen as a continuation of the 1987 ERP. The program
contained market liberalization, trade liberalization, public sector reform,
investments in infras- tructure rehabilitation and social sector programs focused
on primary education and primary health care; and privatization of state-
owned enterprises. It has been remarkably successful and the country has seen an
annual average economic growth rate of about 8 percent since 1994,
substantial improvements in social indicators and an investment boom
involving both local and foreign investors. The ERP is even seen as a model for
post-war rehabilitation and economic reform. For instance, Mozambique entered
the new millennium as the fastest growing country in the world (EIU, 2000).7
This has brought visible improvements to the performance of the economy
and to social indicators, which in turn contribute to investor confidence and
maintain the momentum for growth and investment.8

3.2 The development of Mozambican’s investment frame-

work

The Mozambican economic and FDI performance over the study can be
reviewed on the basis of two regimes that have been in place in the country.
The first period, 1975 - 1985 (the pre-1985 period) relates to the period when
policies that were in place were more or less in the line with the command
system of economic management. The second period, the post-1985 period,
signify some move away from the command system and commenced with the
stabilization and adjustment programs (SAP) of the World Bank (WB) and the
International Monetary Fund (IMF). In the section that follows some of the
major features of the two periods in terms of economic performance and the
FDI policy framework in Mozambique will be reviewed.
7
The Economist Intelligence Unit’s forecast for the year 2000 at the beginning of the year.
8
The country experienced a serious setback in early 2000 due to devasting floods and
tropical storms.

13
3.2.1 The pre-1985 period

Before independence, financing for development projects in Mozambique came

mainly from the Portuguese government, which was the colonial authority.
When the country became independent in 1975, the government had to look
for alternative sources of funding including FDI and aid for their development
programs. At independence, the government adopted a centralized economy
system where the state was a major investor in the economy. This period is
predominantly marked by strong state intervention in the economic
activities.
Immediately after independence, socialist policies were introduced in the
country. These policies favored State Enterprises (SE’s), characterized by heavy
investments in it and total control of the rest of the economy. In short, the
State nearly owned all the basic means of production, and the commercial
sub-sector witnessed very little or no activity during this period. The period
was accompanied by the devastating civil war, and policy makers were faced
with defense strategies, provision of food to the growing migrant population in
the cities. It is against this background that innovative solutions and programs
have to be tailored to invert the prevailing trend. This requires the government
commitment in promoting private sector development through the promotion
of foreign and domestic investment.

3.2.2 The post-1985 period

The Mozambican government has encouraged foreign investment since 1985 when
the first law on foreign investment was introduced. It was replaced in 1993
by a new law that applies to local and foreign investment alike and ensures
national and equal treatment of local and foreign investors in most areas. In
addition, the investment law grants foreign investors protection of property
rights and repatriation of profits. Mozambique is a member of MIGA, OPIC,
and ICSID.9 Finally, a one-stop agency, the Investment Promotion Center, has
9
MIGA: Multilateral Investment Guarantee Agency; OPIC: Insurers against non-commercial
risk International Convention, and ICSID: International Convention for the Settlement of
Investment Disputes.

14
been established in order to undertake timely assistance and authorization of
investment projects (GoM, 2000).
A number of investment incentives have been introduced. Among them are
tax holidays; duty free imports of intermediates (or significant rebates on
duties); a liberal regime related to repatriation of profits and employment of
expatriates. Expenses on training of local employees can be deducted from
profits before tax. Fiscal incentives are more favorable in remote regions in
order to compensate investors for higher costs in areas with inadequate
infrastructure and supply chains. Finally, mentioned above, the government
introduced export processing zones (Industrial Free Zones, IFZ) in relation to
three development corridors. Inside these zones there are full exemption from
customs duties, consumption and circulation taxes and customs handling fees
for investment and intermediate goods, and only a very small tax on income
(GoM 2000).
To qualify for IFZ status, a company must export at least 85 percent of its
output and a minimum investment of USD 50 000 is required. An additional
advantage for foreign investors exporting products manufactured in
Mozambique to third countries is that Mozambique is eligible for duty-free
export quotas to the European Union, the US and other developed countries
under the General System of Preferences (GSP). Mozambique also enjoys
preferential low-duty export quotas to the Eastern and Southern African
markets under COMESA, and has a special trade agreement with South Africa.

3.3 Investment institutions and regulatory framework

In order to encourage, promote and expand private investment in the country,

the Government of Mozambique (GoM) has set out some private development
initiatives. Some of the important factors mentioned as a basis for competitiveness
include conducive investment climate, which focuses on macro-economic stability,
sound policy and regulatory framework for the private investment sector and
strong institutions that run and support the system. It highlights both the
direct and indirect policy interventions, including tax incentives and investment
protection written into law as an integral part of the regulatory institutions.

15
 Figure 1: Trends of FDI inflows to Mozambique (1986-2008)

Source: Own calculation based on WIR database, UNCTAD (2008).

Economic uncertainty reduces the bargaining power of the government of the

host country. Stable macroeconomic policies provide investors with a measure of
predictability. The main macro-economic indicators include economic growth
(GDP), reduced or low inflation (CPI and PPI)10 and reduced or low debts
and deficits. Since the implementation of the ERP in 1987 the surveillance
and maintenance of macro-economic policies in Mozambique is a
consequence of agreements with the IMF and the World Bank (UNCTAD
2001). The figure 1 displays the FDI trends in Mozambique at a global level in
the period from 1986 to 2008. The FDI inflows reached $ 587 million in 2008,
surpassing the previous record level of $ 381 million in 1999. Several factors
explain this upward trend in the recent years. First, regulatory frameworks
for FDI are becoming more relaxed in the country. Second, the business climate
has improved and economic growth has been robust.

3.3.1 The FDI institution framework

The Investment Promotion Centre11, Central Bank and the customs officials are
among the more important institutions (example laws, customs, taxes, etc.) and
10
Consumer Price Index and Purchasing Price Index
11
Under the supervision of the Minister of Planning and Finance, the Investment
Promotion Centre (CPI) is responsible for the promotion of investment and provides
advisory service to Government bodies on investment matters.

16
organizations responsible for facilitating domestic and foreign investments. The
quality of these institutions is reflected by competent personnel and efficient
institutions capable of delivering services of high quality in as short a time as
possible. Currently the GoM policy interventions aims to reduce bureaucratic
procedures and develop bureaucrats’ capacity to negotiate, and improve service
delivery to investors as well as meet the demands of the global economy (UNC-
TAD 2001).
The following Table 1 displays foreign direct investment approved by the CPI
in Mozambique over the period 1990 - 2007. Most of the investment has been
in the south of the country, in and around the capital city, Maputo. From
January 1, 1990 through December 31, 2007 CPI approved a total of 2,434
projects (both foreign and national), involving over USD 5.5 billion in foreign
direct investment in 2007 alone. Some of these approved projects turned out to
be smaller than planned or not implemented at all, however. Approved projects
do not represent the actual FDI for any given year for this reason.

Table 1: FDI Projects in Mozambique, December 2007

Year Projects FDI ($ mil)

1990 31 20
1991 25 21
1992 27 77
1993 29 46
1994 123 136
1995 166 60
1996 270 97
1997 184 558
1998 209 209
1999 235 101
2000 179 230
2001 129 528
2002 128 559
2003 112 122
2004 105 122
2005 139 165
2006 157 162
2007 186 550

Source: UNCTAD, 2008.

17
 Under the tutelage of international agencies like the World Bank and the
IFC12, which provide financial support, the GoM has introduced reforms of its
investment laws and has reduced bureaucratic red-tape to make it easier to do
business in Mozambique. The time and money required to start a new business
are indicators of the bureaucratic burden of the country’s investment climate.
The IFC (2010) estimated that the median time to register a company in
Mozambique is 26 days and the country is ranked 135 out of 183
economies.13 Singapore is the top ranked economy in the Ease of Doing
Business. Other government departments that are involved in the attraction of
FDI to Mozambique include: The Ministry of Trade and Industry, the Ministry of
Foreign Affairs, the ministries and agencies associated with specific sectors such
as mining, energy and tourism.

Table 2: FDI by sector in 2007

Sector N◦. of Projects FDI ($ mill) Percentage

Industry 64 192.7 34.4%
Mining / Energy 5 5017.0 2.7%
Agriculture & Agro-Industry 16 52 8.6%
Banking & Insurance 3 1.0 1.6%
Tourism / Hotels 46 138.0 24.7%
Transport & Communication 3 25.6 1.6%
Construction 3 11.4 1.6%
Aquaculture & Fishing 4 9.7 2.2%
Others 42 53.6 22.6%
Total 186 5501.8 100%

Source: UNCTAD, 2008.

In the Table 2 the breakdown of all projects approved in 2007 (foreign

and national) by sector is provided. FDI amounted to just over USD 5 billion
(for five projects). The majority of investment is in the extractive industries
and agriculture. It is estimated that these approved projects, along with
locally sourced direct investment projects, will create over 19,633 jobs.
12
International Finance Corporation
13
see World Bank report on “Doing Business 2010 - Mozambique.

18
3.3.2 The FDI regulatory framework

The two laws that directly regulate national and foreign private investment into
Mozambique are the Law on Investment,14 approved on 24 June 1993 and the
Regulation of Investment Law (No 14/93), approved on 21 July 1993 (hereafter
the Regulation of Investment Law) with changes approved by Decree No 36/95.
Article 7 of the Law on Investment No 3/93 outlines the GoM’s objectives for
establishing laws and attracting investments as the:

• Development, rehabilitation, modernization or expansion of economic

infrastructure;

• Expansion and improvement of national production capacity or capacity

to render services;

• Training, expansion, and development of national entrepreneurs and

Mozambican business partners;

• Creation of jobs for national workers and the raising of professional skill
levels of the Mozambican labour force.

• Technological development and the improvement of entrepreneurial pro-

ductivity and efficient;

• Increased diversification of exports;

• Generation of foreign currency;

• Reduction and substitution of imports;

• Improvement of the supply of domestic markets; and

• Direct or indirect contribution towards improving the balance of payments

and government budget revenue.

The Law on Investment makes provision for framework where national and
foreign private investments qualify for the guarantee and incentives schemes
14
Replacing Law No 4/84 (18 August 1984) and Law No 5/87 (January 1987). It does not
apply to investments made in the areas of prospecting, research and production of petroleum.

19
offered by the GoM. The law deals with non-discrimination between foreign and
domestic investors and the protection and guarantee of investments. Foreign
investors, employers and workers are subject to the same duties and obligations
applicable to nationals. Companies involved in FDI entitled to access domestic
borrowing on the same terms and conditions applicable to Mozambican compa-
nies.
Furthermore, the GoM guarantees the concession of tax and customs incen-
tives granted in the Code of Fiscal Benefits for investors complying with the
law. In the event of a dispute between the GoM and foreign investors
concerning existing investment projects in Mozambique, the ICSID will arbitrage
the matter. The Regulations on Investment Law and Decree No. 36/95 of 8
August deals with the Council of Ministers (CoM) which comprises the Minister
of Planning and Finance, the Minister of Industry and Commerce, the Minister
of Tourism, the Minister of Public Works and Housing, the Minister of
Agriculture and Fishing and the Minister of Environmental Coordination. The
CoM determines the minimum value of direct national and foreign
investment. It is also the responsible for the IFZ regime and has the final
say on granting IFZ status. The coordination and operations of the IFZ are
managed by the IFZ Council (established on 21 September 1999) with the CPI
being responsible for issuing
certificates to companies that intend to operate in the IFZ.

4 Discussion on dataset and empirical method

4.1 Data sources

This section presents a general discussion on dataset description of the variables

used in this study. Data where drown from a number of data sources, including
the World Bank Development Indicators (WB), International Financial Statistics
(IMF) and United Nations Conference on Trade and Development (UNCTAD).
The Sample period is from 1960 to 2007 but a number of time-series datasets
are incomplete for this time span especially data for Mozambique.

20
4.2 Description of the variables

Variables are chosen according to the theories n FDI discussed in section 2.1
and the empirical studies in section 2.2. Macro-data and proxies are used rather
than firm specific data, although the foundation of some of the theories and the
functional forms are based on micro foundations. There is a number of FDI
variables included in World Development Indicators dataset: net FDI; BOP in
current UDS; net inflows as percentage of gross capital formation; net inflows
BOP in current USD and net FDI inflows as percentage of GDP.

4.2.1 Dependent variable

The dependent variable in most studies is some measure of the ratio of FDI
to GDP, but the definition of FDI and the data sources differ. Asiedu (2002)
uses the ratio of FDI flows to GDP “as is the standard in the literature” from
World Bank data sources. This net flow is also employed by Chakrabarti
(2001) while Schneider and Frey (1985) use net foreign investment per capita
in US dollar and obtained this data from United Nations Statistical yearbook
and from the World Development Report. In line with the approach used in
the FDI literature, the dependent variable used in this study is the net FDI
inflows as % of GDP measured in US dollar terms.

4.2.2 Independent variables

Market size: The market size hypothesis states that multinational firms are
attracted to a large market in order to utilize resources efficiently and exploit
economies of scale (Chakrabarti, 2001). Market size has been represented by real
GDP per capita. Real GDP per capita is included in the regression as measure
of market attractiveness and FDI is expected to be positively related to this
variable.

Macroeconomic stability: There is a widespread perception that macro-

economic stability shows the strength of an economy and provides a degree of
certainty of being able to operate profitably (Balasubramanyam, 2001).
Exchange

21
rates are used as proxy variable for macro-economic stability. A strong
exchange rate is often interpreted in the empirical literature as an indicator of
greater “competitiveness” of the host country. Stable exchange rates are
expected to have positive impact on FDI.

Infrastructure: Infrastructure covers many dimensions ranging from roads,

ports, railways and telecommunication systems to the level of institutional
development. The availability of well-developed infrastructure will reduce the
cost of doing business for foreign investors and enable them to maximize the
rate of return on investment (Morisset, 2000). Therefore countries with good
infrastructures are expected to attract more FDI. It is a standard practice to
measure infrastructure by the number of telephone lines per 1000 people in a
country. Asiedu (2004) argues that this measure does not include mobile
phones. Moreover, it only captures existing infrastructure and fails to take into
account potential infrastructure. This variable is expected to be positively
correlated with FDI.

Openness: Mixed evidence exists in the literature supporting the significance

of openness, which is normally measured by the ratio of trade (imports+exports
divided by GDP). This measures the openness of an economy and also often
interpreted as a measure of trade restrictions. Asiedu (2001) argued that the
impact of openness on FDI depends on the type of investment and a distinction
is made between investments that are market seeking and investments that are
resource seeking (export-oriented). This variable is expected to have a
significant effect.

Liberalization: Liberalization of trade and FDI regimes are assumed to have

a positive influence on the inflow of FDI since they facilitate a freer trade and
investment in conjunction with the repatriation of dividends and profits to home
countries (Bende-Nabende, 2002). As explained in section three,
Mozambique has been introducing some liberalization measures since 1985
and a dummy variable is used to capture the effect of the change in policy
environment on FDI.

22
The dummy variable assumes a value of 0 for the pre-liberalization period (i.e.
up to 1984), and 1 for the post liberalization period (from 1985 onwards). The
dummy variable is expected to have a positive sign.

4.2.3 Data availability

As in all empirical studies, when choosing independent variables and estimating

FDI determinants empirically, data availability and data quality is very important.
The choice of independent variables for this study is constrained by the data
availability, as is mostly the case with time-series data in developing countries.
Asiedu (2002) for example states that time-series data on important factors such
as real wage, tariff rates, trade taxes are not readily available for most developing
countries. Mozambique is not an exception of the problem whereas data on real
wages, for instance, are not available over the (entire) study period.

4.3 Descriptive statistics

Table 3 highlights the summary statistics of the variables used in the OLS
regression analysis (n = 48).

Table 3: Summary Statistics for the Sample Period 1960 - 2007

Variables FDI RGDPC OPEN XRATE TEL LIB

Maximum 39 48 47 24 7.7 1
Minumum 1 1 1 1 0.12 0
Mean 19.2 24.5 23.8 7.4 0.67 0.48
Std. Deviation 10.5 14 13.6 7.1 1.24 0.50
Coef. of Variation 0.55 0.57 0.57 0.98 1.85 1.05
Skewness 0.17 0.03 0.37 1.02 4.35 0.08
Kurtosis 5.1 1.8 1.8 2.6 23.4 1.01

Table 4 shows the pairwise correlation for dependent variable and the
explana- tory variables. The regressors seems to be highly correlated with FDI
inflows, lending support to the postulated model. There is no evidence of
collinearity between explanatory variables.

23
 Table 4: Estimated Correlation Matrix of Variables

FDI RGDPC OPEN XRATE TEL LIB

FDI 1
RGDPC 0.14 1
OPEN 0.68 0.11 1
XRATE 0.73 0.14 0.75 1
TEL 0.28 0.45 0.46 0.47 1
LIB 0.76 -0.14 0.87 0.77 0.37 1

4.3.1 Econometric methodology

Since this study covers the period 1960-2007 and the variables discussed in the
previous section constitute time-series information of one country, the appropriate
modelling strategy is one involving time-series analysis through OLS regression
model. OLS econometric techniques are used to estimate the significance of
a number of determinants of FDI. Some technical discussion of tests for
series stationarity and series co-integration are shown in Appendix A.
Variables used in the time-series are determined according to data availability.
It is desirable to use as many variables as possible for as many series as possible.
However, not all data series are available. Model specification is done according
to theoretical and empirical guidelines. Theories used are presented in Section 2
and the models tested empirically and variables are shown in the Section 5.

5 Model specification

The general form of the model estimated has the following form:

FDI = f (RGDPC, OPEN, XRATE, TEL, LIB) (1)

Where: FDI = Foreign Direct Investment as percentage of GDP

RGDPC = Real Gross Domestic Product per capita
OPEN = Openness (imports+exports by GDP)
XRATE = Annual rate of exchange
TEL = Telephone lines per 1000 people
LIB = Measure of liberalization (dummy variable)

24
 The model employed can be given by:

FDIt =α + β1RGDPC + β2OPEN + β3XRATE + β4TEL+

(2)
+ β5LIB + ϵt

An important consideration to be made in relation to estimating the model

given in equation (2) is to do with the existence of spurious regression. Granger
and Newbold (1974) have shown that results based on models such as the given
in equation (2) may give rise to “spurious regression”. Spurious regressions
occur when results from the model show promising diagnostic test statistics
even where the regression analysis has no meaning (Gujarat, 2003). Because of
this problem, the first step in any time-series analysis is to test for the
stationarity of the variables. As can be seen in the appendix, appropriate tests of
stationarity and co-integration have been conducted to rule out “spurious
regression” in the study.
The stationarity and co-integration tests suggest that the model given in
equation (2) should be estimated using the differenced variables. The final short
run model estimated therefore has the following form:

∆FDIt =α + β1∆rgdpc + β2∆open + β3∆xrate + β4∆tel+

(3)
+ β5∆lib + ϵt

Based on this short run model, four regressions have been curried out to
examine the determinants of FDI. The next section analyses the results from
the four regressions.

6 Results and Discussion

This section presents the regression parameters estimated from the sample data,
and discusses the findings.

25
6.1 Estimation results
The results of the OLS regression analysis are presented in Table 5. As can be
seen from the table, the estimated coefficient of the market size variable
(RGDPC) has the expected positive sign and significant coefficient in four
regressions. This finding is in line with the hypothesis that a growing economy
attracts more FDI.

Table 5: OLS Estimation (1960-2007). Dependent Variable: FDI Inflows

Variables Specification
Model 1 Model 2 Model 3 Model 4
RGDPC 0.129 0.771∗∗ 0.784∗∗ 0.261∗∗
(0.1294) (0.0151) (0.0124) (0.0031)
OPEN 3.997∗∗∗ 4.040∗∗∗ 3.999∗∗∗ 4.397∗∗∗
(0.0051) (0.0045) (0.0059) (0.0002)
XRATE −0.756∗∗ −0.774∗∗ −0.753∗∗ −0.836∗
(0.0334) (0.0119) (0.0039) (0.0116)
TELEPHONE −2.046∗ −2.217∗
(0.0328) (0.0072)
∗∗ ∗∗
LIB DUMMY 2.252 ∗∗
2.301 2.183 2.275∗∗
(0.0026) (0.0190) (0.0039) (0.0003)
Constant 5.673 5.810∗∗ 5.885∗∗ 6.134∗
(0.191) (0.019) (0.008) (0.0177)
N 48 48 48 48
R¯2 0.55 0.57 0.59 0.67
RMSE 0.619 0.617 0.621 0.624

Note: Figures in parenthesis denote p-values. ***, **, * indicates statistical significant at 1 %,
5% and 10% levels of probability respectively. RMSE denotes the Root Mean Square Error (the
standard error of the regression).

An important finding is the positive and significant effect of export

orientation, i.e., openness measured by the ratio of trade (imports +
exports/GDP). It is significant at 1 % level of significance in all regressions.
This finding suggests that FDI in Mozambique is of the vertical type15 which
is normally export oriented and tends to be unaffected by the market size of
the host economy. This therefore, explains the strong positive effect of export
orientation on FDI. Similarly, the liberalisation dummy is found to be a
significant determinant of FDI, with the estimated coefficient possessing the
expected sign in all regressions. 15FDI in search of low cost inputs is called vertical FDI.
The low cost inputs can be primary
26
commodities or raw material (Lim, 2001).

27
 The infrastructure indicator, telephone lines per 1000 people, is found to yield
a negative and significant coefficient (regression 4). This result may be explained
by the poor telecommunication facility which is detrimental to FDI inflow
into the country. UNCTAD (2008), pointed out that one of the specific
economic challenges and constrains identified by private investors in
Mozambique is the poor infrastructure facilities, in particular in the area of
telecommunications, transport and power supply.

7 Conclusion and Policy Implications

As discussed in the previous sections, the issue of rapid growth in FDI over
the last few decades has spurred a large body of empirical literature to
examine the determinants and the growth enhancing effects of FDI. This paper
intended to explore some of these theoretical and empirical literature
pertaining to the determinants of FDI in the context of developing and developed
countries. From the empirical analysis conducted on FDI for Mozambican
economy and its findings show that market size, export orientation (openness) and
liberalization have a significant positive impact on FDI, while macroeconomic
instability and low level physical infrastructure have a negative impact on the
same. I conclude summarizing this findings as follows:

• The positive and significant effect of market size on FDI emphasizes the
crucial role of growing economy in stimulating investment by foreign as well
as domestic investors. Keeping up the growth momentum and ascertaining
its sustainability is a key to attracting more FDI. In this regard,
furthering the growth of market size is some of the important measures
essential to attract FDI.

• The positive and significant export orientation coefficient signifies the

importance of implementing a more outward looking growth strategy.

• The significant positive effect of liberalization on FDI indicates that an

efficient environment that comes with liberalized economy is likely to

28
 attract foreign investors. To induce more FDI to Mozambique, the govern-
ment needs to focus on improving the investment climate through further
measures of liberalization as well as creating efficient bureaucracy that
facilitates speedy and operation of foreign investors. Further measures
aimed at promotion of domestic investment too is essential for the inflow
of FDI given that foreign investment may depend to degree on how the
domestic private sector is treated.

• The negative and significant exchange rate coefficient signifies the impor-
tance of a more focused macroeconomic policy environment that strengthens
the economy and builds confidence for potential investors. Necessary steps
have to be taken to stabilize exchange rate through the adoption of sound
fiscal and monetary policies.

• The significantly negative coefficient of the infrastructure variable (tele-

phone lines per 1000 people) highlights the need for big investment in
infrastructural development, which is essential for the creation of a
produc- tive business environment. These should be concerted effort to
upgrade the country’s poor infrastructure particularly in relation to
transportation, power and communication.

29
A Appendix on statistical tests

A.1 Test for stationarity

Stationary time-series is said to exist if the mean and variance are constants
over time while the value of the covariance between two periods depends only
on the gap or lag between the two periods and not the actual time at which the
covariance is computed (Gujarati, 2003). If the time-series is not stationary, the
mean, variance or covariance will not be constant and one is likely to end up
with spurious regression where statistical inference on the basis of the classical
regression model will be invalid.
For the purpose of testing the stationarity of the time-series used in this
study, Dicky-Fuller (DF) and Augmented Dicky-Fuller (ADF) tests have been
conducted. The null hypothesis in these tests is that the underlying process
which generated the time-series is non-stationary. This will be tested against the
alternative hypothesis that the time-series information of interest is stationary.
If the null hypothesis is rejected, it means that the series is stationary, i.e. it
is integrated to order zero. If on the other hand, the series is non-stationary,
it is integrated to higher order and must be differenced till it becomes
stationary.16 As can be seen from the results given in Table 6 below, all the
variables used
in the model, except OPEN, are not stationary in. This implies that the null
hypothesis cannot be rejected and that time-series has to be differenced. I then
conduct the same tests on the first difference of the time-series. As can be seen
from the test results on the first difference in Table 6 below, the null hypothesis
has been rejected for all variables indicating that all variables become stationary
at their first difference.

A.2 Test for co-integration

Having tested the series for stationary, the next step of time-series analysis
is testing for co-integration which amounts to checking whether the linear
16
The order of integration of a time-series data set shows the number of times the series has
to be differenced before it becomes stationary (Gujarati, 2003).

30
 Table 6: Unit-Root Tests on Variables

Levels First Difference

DF ADF(1) DF ADF(1)
Variables Without With Without With Without With Without With
Trend Trend Trend Trend Trend Trend Trend Trend
FDI −1.74 −2.70 −4.50 −2.10 −8.47 −8.40 −5.28 −5.30
(−2.94) (−3.51) (−2.94) (−3.51) (−2.94) (−3.51) (−2.94) (−3.52)
RGDPC −1.66 −1.71 −1.79 −1.80 −6.66 −6.58 −5.15 −5.10
(−2.94) (−3.51) (−2.94) (−3.16) (−2.94) (−3.51) (−2.94) (−3.52)
OPEN −2.13 −5.13 −1.68 −4.56 −8.93 −8.83 −8.17 −8.09
(−2.94) (−3.51) (−2.94) (−3.51) (−2.41) (−3.51) (−2.94) (−3.52)
XRATE −0.76 −2.45 −1.04 −2.95 −5.90 −5.90 −4.48 −4.50
(−2.94) (−3.51) (−2.94) (−3.51) (−2.40) (−3.51) (−2.94) (−3.52)
TEL −3.44 −4.19 −2.49 −3.17 −9.55 −9.44 −5.56 −5.80
(−2.94) (−3.51) (−2.94) (−3.51) (−2.94) (−3.51) (−2.94) (−3.52)

95% critical value in parenthesis.

combination of the variables is (also) stationary or not. It requires that the

variables of interest have the same order that a linear relationship among them
can be expected. Variables are said to be co-integrated if a long run equilibrium
relationship exists among them. Engle and Granger (1987) argue that for such
relationships to exist, the error terms of the model should be stationary.

Table 7: Unit-Root Test results on Residuals

DF ADF (1)
Without trend -4.8074 (-5.3798) -4.5972 (-5.3798)
With trend -4.8140 (-5.7933) -4.5901 (-5.7933)

95% critical value in parenthesis.

I have applied the Engle-Granger procedure to test for co-integration. The

first stage of the co-integration test involves estimating equation (2) (given in
section 4.2) and saving the error terms. Then the DF and ADF tests are applied
on the error terms. If the error terms are found to be stationary, the variables
are said to be co-integrated and this necessitates the estimation on an Error

31
Correction Model (ECM) involving long run relationships. If on the other hand,
the variables are not co-integrated then the modelling should proceed with the
differenced time-series.
Table 7 above reports the test statistics from the unit root tests. As can be
seen from the table, reported test results are lower, in absolute terms, than the
critical values both with and without trend. This suggests that the variables in
equation (2) are not co-integrated. In other words, an Error Correction Model
(ECM) is not required.

B Appendix about Mozambique

B.1 Land geography and climate

Figure 2: Mozambique: Geographical location

Mozambique lies on the east coast of Southern Africa. Measuring a total of

some 799,380 sq km in area and population of 22.4 inhabitants17. The country
has borders with the United Republic of Tanzania, Zambia, Malawi, Zimbabwe,
South Africa and Swaziland. The extensive coastline stretches 2,515 km. Two of
17
last population census in 2007.

32
Africa’s major rivers - the Zambezi and Limpopo - flow through Mozambique
to the Indian Ocean. The climate varies from subtropical to tropical (south
to north) and is influenced by the monsoons of the Indian Ocean and by the
warm current of the Mozambique Channel. Temperatures range from 13 to 24
degrees Celsius during the dry season which is May to September, and from
22 to 31 degrees Celsius during the wet season, namely October to April. The
official and business language is Portuguese. English is widely spoken in business
and academic circles. The local languages include Emakua, Shangane, Bitanga,
Xitswa, Chope, Ronga, Elomwe, Chuabo, Sena, Shona, Ndau, Nyandja, Kimwani
and Chimakonde.

B.2 Economic overview

The Mozambique government has moved away from its initial post-independence
centrally-planned economy through the introduction of free market reforms.
The country’s exchange rate is now determined by market forces, as are interest
rates and prices. Government subsidies and restrictions on imports have been
lifted in a bid to open up the economy, along with the reduction and
simplification of import tariffs and the liberalisation of crop marketing. Other
economic reforms include the introduction of a privatisation programme which
involves the entire banking sector as well as various State owned manufacturing
operations.

Table 8: Macroeconomic indicators (2008 - 2011)

2008 2009 2010 2011

Real GDP growth 6.8 5.4 5.8 6.1
RGDP per capita 10.0 11.0 12.9 14.6
CPI Inflation 10.3 3.4 9.2 4.4
Budget balance % of GDP -2.5 -5.7 -3.3 -2.2
Current account % of GDP -12.2 -14.2 -12.3 -9.5
Exchange rate 23985.3 25975.6 26728.7 26725.7
Source: African Economic Outlook, 2010 - Mozambique. Figures for 2009 are
estimates; for 2010 and later are projections.

33
 Mozambique weathered the global financial crisis relatively well, maintaining
strong, if lower growth than in 2008 while inflation was subdued. The limited
exposure of the country’s banking system to international financial markets
minimised the direct impact of the global crisis. Supportive government
measures, such as fuel subsidies, helped sustain growth together with an
increase in agricultural output. As can be noted in Table 8, Gross domestic
product (GDP) growth fell to 5.4% in 2009 from 6.8% in 2008, which was
better than IMF estimates for around 4.5% but below the government’s target of
6.7%. Growth continued to be driven mainly by large foreign investment in
mineral resources and services while the agro-industry, energy and construction
sectors benefited from strong donor support. Growth is expected to pick up to
5.8% in 2010 and 6.1% in 2011, strong but still below trend because of the
impact of the global financial crisis on exports and commodity prices.

B.3 Human development context

Poverty levels in Mozambique remain high in spite of the sustained strong GDP
growth over most of the past decade. The last Human Development Index (HDI)
reading for Mozambique ranked the country 172 out of 182. There has been some
progress in education, with student numbers from primary school to university
jumping to 6 million by 2008 from 4 million in 2005. Primary school enrollment
alone rose to 4.2 million from 3.7 million in that period. There are 1 000 new
teachers per year in training.

34
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