Chinese Investment In Africa Has Had ‘Significant And Persistently Positive’ Long-Term Effects Despite Controversy

Chinese foreign direct investment in Africa has had ‘significant and persistently positive’ long-term effects despite being highly controversial, according to new research by the London School of Economics and Political Science.

The study, led by Riccardo Crescenzi, Professor of Economic Geography at LSE, analysed the effects of Chinese investment in Ethiopia over 20 years. The results show that Chinese foreign direct investment (FDI) sets in motion a process of transformation in the local economy that damages local competitors but – at the same time – benefits local suppliers to the new Chinese firms as well as their local clients. The final long-term result of this process – with domestic winners and losers – is a significant and persistent increase in overall domestic economic activity to the benefit of local communities in the local area hosting new foreign investment.

It concludes that although there is no instantaneous impact on local growth, the positive effects are seen after 6 to 12 years.

The paper cites the controversy over Chinese foreign direct investment in Africa: “Although in terms of value (both flows and stocks) Africa still accounts for a relatively small share of total global Chinese outward FDI, these investments have recently attracted significant attention due to their sectoral and geographical diversification, as well as their economic and geo-political implications.

“A lively debate on the effect of this specific form of FDI presents a wide spectrum of views, spanning from the growth-enhancing nature of Chinese investment to a more pessimistic, neo-colonialist interpretation. The ongoing tensions between the USA and China have further polarised views on Chinese FDI in Africa.

“In this research, we offer causal evidence on the impact of Chinese FDI in Ethiopia, which constitutes a large manufacturing hub where China is heavily investing both to serve the local market and to export to other African countries and beyond.”

Professor Crescenzi and Nicola Limodio, Assistant Professor of Finance at Bocconi University, Milan, conducted the research, using Ethiopia as a case study, by leveraging an innovative combination of data on firms, investments and local economic activity. They focussed on analysing medium and large manufacturing firms and Chinese FDI location choices. They also examined night lights data from two different satellites provided by the National Oceanic and Atmospheric Administration. One offers data from 1992 until 2013, while the other from 2012 until 2019. This type of data is increasingly being used by economists to study economic activity, particularly in developing countries where conventional sources of official statistics are scarce.

They found that Chinese FDI is increasingly directed to Ethiopian districts which specialise in the same manufacturing sectors that are being targeted by export taxes domestically in China.

The paper concludes: “Our results show that firms operating in districts receiving Chinese FDI shrink their operations significantly: lowering production, employment, investment, and raw material inputs. We also observe that the prices charged by such firms report a large decline, which is in line with the hypothesis of an increase in local competition.

“Meanwhile, firms operating in the relevant upstream and downstream sectors in the same district benefit from Chinese FDI and expand their operations, while firms in other sectors remain unaffected.

“We go beyond firm-level estimates and study the aggregate effect of Chinese FDI through a district panel of satellite night lights. This leads us to verify that the positive and negative effects of Chinese FDI cancel each other out at the aggregate level at the time of the investment, with our results reporting a well-estimated zero effect on local economic condition. However, we observe that in the medium run the positive effects of Chinese FDI outpace the negative effects.

“Overall, our findings cast some doubts on the fierce and often-times ideological debate around Chinese presence in Africa. We show that the effects of Chinese FDI are highly heterogeneous (diverse), but overall positive in the medium run. We hope that this empirical contribution may offer grounds for a fruitful, evidence-based discussion, and subsequent refinement of guidance surrounding optimal trade and investment policies.”

Professor Crescenzi commented: “At a time when international development budgets are being cut in the UK and across advanced economies it is crucial to look at all possible sources of economic growth and recovery for Africa. The poisonous rhetoric of the ‘Chinese Virus’ risks to overshadow an important avenue for development that, instead, needs to be better understood and supported within appropriate regulatory frameworks. The unprecedented challenges of the post-Covid world economy call for fresh approach to economic opportunities based on solid evidence and free from ideology.”

Dr Limodio added: “The discussion on Chinese FDI in Africa increasingly radicalized in the recent years to the detriment of the local African communities. Our paper aims at offering an impartial and scientific view of this transformative phenomenon. Our findings highlight that the opening towards international markets can benefit societies but creates winners and losers. These results point toward a fundamental challenge for the next decades: how to redistribute the gains of trade, finance and investment to create more prosperous and dynamic societies.”

The Impact of Chinese FDI in Africa: Evidence from Ethiopia by Riccardo Crescenzi and Nicola Limodia is to be published as a Discussion Paper by both the LSE Institute of Global Affairs (IGA) and the Department of Geography and Environment.